I flinched when, at a recent BBC World Debate Zeinab Badawi asked Bob Zoellick why, when there are so many economists at the World Bank, they couldn’t do anything about protecting developing countries from the impact of the global crisis. Were we asleep at the wheel? Montek Ahluwalia gave us temporary respite by pointing out that the economists in the industrialized countries didn’t see the global recession coming even in their own countries, much less that it would spread to poorer countries.
But this begs the question of why economists didn’t forecast the global financial and economic crisis. Recently there have been two thoughtful pieces addressing this question.
John Kay (hat tip to my colleague Apurva Sanghi) faults economists’ desire to develop a general theory of everything. Meanwhile, Barry Eichengreen (hat tip to Dani Rodrik) says that there is no problem with economic theory, but a problem with its application:
In fact, large swaths of modern economic theory focus squarely on the kind of generic problems that created our current mess. The problem was not an inability to imagine that conflicts of interest, self-dealing and herd behavior could arise, but a peculiar failure to apply those insights to the real world.
My own thinking is closer to Barry’s. Incorporating the factors that created problems in the financial markets makes the theory complex. But to be effective in the real world, to be able to communicate economic ideas, you have to simplify. Sometimes, you start believing your simplifications as if they were the general theory.