As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.I have two comments:
Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.
- There were plenty of economists (the so-called "heterodox") who did NOT believe in this mathematical fantasy. I am one of them [read this, this and this], but others often identify themselves as Austrians (as in Ludwig von Mises), experimentalists, etc. Krugman is overstating the "autism" of the profession.
- Many economists work at universities, under an incentive system that rewards mathematical elegance over realism. My favorite example of how this doesn't matter in reality come from an interview with Nassim Taleb. He was asked if he was bothered that money managers (and economists) rejected his warnings of risk in the markets. "No, I just bet against them..." and made a killing, I'm sure!
Bottom Line: Math is fun, but it's not very good at describing how people behave. Real