The Naked Economist

There is little doubt that climate change represents the greatest market failure of all time. But it is not just a market failure, it points to the failure of classical economics and those who would place their confidence in its clearly outdated assumptions. This story from Scientific American says it well:

The Economist Has No Clothes
Scientific American
By Robert Nadeau
April 2008

Unscientific assumptions in economic theory are undermining efforts to solve environmental problems

The 19th-century creators of neoclassical economics—the theory that now serves as the basis for coordinating activities in the global market system—are credited with transforming their field into a scientific discipline.

But what is not widely known is that these now legendary economists—William Stanley Jevons, Léon Walras, Maria Edgeworth and Vilfredo Pareto—developed their theories by adapting equations from 19th-century physics that eventually became obsolete.

Unfortunately, it is clear that neoclassical economics has also become outdated. The theory is based on unscientific assumptions that are hindering the implementation of viable economic solutions for global warming and other menacing environmental problems. clip

The strategy the economists used was as simple as it was absurd—they substituted economic variables for physical ones. Utility (a measure of economic well-being) took the place of energy; the sum of utility and expenditure replaced potential and kinetic energy.

A number of well-known mathematicians and physicists told the economists that there was absolutely no basis for making these substitutions. But the economists ignored such criticisms and proceeded to claim that they had transformed their field of study into a rigorously mathematical scientific discipline.

Strangely enough, the origins of neoclassical economics in mid-19th century physics were forgotten. Subsequent generations of mainstream economists accepted the claim that this theory is scientific. These curious developments explain why the mathematical theories used by mainstream economists are predicated on the following unscientific assumptions:

The market system is a closed circular flow between production and consumption, with no inlets or outlets.

Natural resources exist in a domain that is separate and distinct from a closed market system, and the economic value of these resources can be determined only by the dynamics that operate within this system.

The costs of damage to the external natural environment by economic activities must be treated as costs that lie outside the closed market system or as costs that cannot be included in the pricing mechanisms that operate within the system.

The external resources of nature are largely inexhaustible, and those that are not can be replaced by other resources or by technologies that minimize the use of the exhaustible resources or that rely on other resources.

There are no biophysical limits to the growth of market systems. (clip)

Because neoclassical economics does not even acknowledge the costs of environmental problems and the limits to economic growth, it constitutes one of the greatest barriers to combating climate change and other threats to the planet." (more)

I've written and spoken often about the need to include "all the costs" in the market in order for the market to actually send the correct signals, but quite frankly I had no idea that such nonsense was so intrinsic to the foundations of this school of thought.

Hopefully, this school of thinking will realize that it is obsolete,

and those Naked Economists will put on some clothes.

Before we all are.

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Illustration courtesy of Matt Collins