The chancellor needs to ditch the neo-classical approach to economic policy making, and embrace new economic thinking that corresponds to the real world
George Osborne’s economic programme is simply not going to plan. Public finance figures published last week showed that in July Britain borrowed £600 million – markedly different to the £2.8 surplus experienced a year ago. If borrowing continues at this rate, the government will likely overshoot its expected borrowing figures for the year.
Adding to the bad news, the economy continues to struggle – shrinking by a further 0.5% in the second quarter of the year. So what has the coalition’s response been, given the unexpected deterioration in the borrowing and growth figures? Stick to the original plan.
Despite slight changes, the chancellor’s overwhelming commitment to its failing plan is puzzling – receiving criticism from across the political spectrum. Critics have been calling for the coalition to change course with many offering various alternatives to give the economy the boost it desperately needs.
There are those, especially following the financial crisis and subsequent recessions, who go further, suggesting that the neo-classical approach to economic policymaking is fundamentally flawed and that we need an entirely new approach to managing the economy.
If the government was to draw lessons from this new economic thinking – for example, complexity and evolutionary economics – the chancellor would have to acknowledge that policymaking needs to be more flexible and willing to break with organisational routines.
Advocates of new economic thinking suggest there is a lot more to be learnt from heterodox economics. To flesh this out, the IPPR has recently published a collection of essays Complex new world: translating new economic thinking into public policy which aims to take insights from new economic thinking straight to policymakers.
The economy described in this collection is a far more accurate representation of the real economy, in marked contrast to the world described by neo-classical economics. This approach acknowledges that actual human behaviour and the complex interactions we have with each other lead to particular economic outcomes. It also allows for surprises – with individuals and institutions learning and adapting as a result – and recognises the importance of failure for policy evolution, something most governments struggle to allow.
Complexity and evolutionary economics acknowledge that individuals are not rational decision makers, and often lack the ability to process the range of options available to us. As a short cut people tend to copy and imitate others, or use rules of thumb to come to their decisions. This means that decision-making in the real world is not static or optimal, nor does it follow the rational expectations hypothesis of traditional economic theory.
This has significant implications for macroeconomic policy, as macro level patterns and outcomes can only be fully understood by an appreciation of activity and interactions at the individual level.
It follows that policy needs to be suitably tailored to specific problems. It cannot be prescriptive or dogmatic. Additionally, carrying out the relevant cost benefit analysis or correcting a perceived market failure through taxes or subsidy is no longer sufficient. What evolutionary or complexity approaches tells us is that there is no silver bullet to solve economic challenges. A more integrated and holistic policy approach towards economic systems is likely to produce better results.
Overall, drawing lessons and policy ideas from new economic thinking is still a work in progress, but it is important to start the debate about how we can improve economic policymaking for the better. This begins with thinking about designing real policy for the real world.
Amna Silim is a researcher at the Institute for Public Policy Research