!VAR HAGENDOORN

New Economic Thinking

Last year George Soros pledged 50 million dollar to help establish The Institute for New Economic Thinking. The founding of the institute was precipitated by the recent economic crisis, but of course an economic crisis does not entail a crisis in economics. As I have written before there are many subdisciplines in economics besides macroeconomics and financial economics and in some areas progress is being made in understanding the nature of economic activity. In my view the narrow focus on the current financial crisis is a sign of myopia. The premise that the financial crisis was caused by flaws in economic theory and that new theories will prevent future crises is also wrong in my humble opinion.

The institute organized an inaugural conference at Cambridge University in April, which received quite a bit of media coverage. For an institute that claims to promote new economic thinking the list of speakers was quite disappointing. There was no Daron Acemoglu, no Esther Duflo, no Emmanuel Saez and no Andrei Shleifer. Of course they may have had other obligations or they may have considered attending the conference a waste of their time.

On the website there is a lot of talk about the need for new paradigms and empowering the next generation of economists. New paradigms, models and approaches are being tried out by young and old economists around the world so there's no real need for a new institute to foster it.

Where the institute hits the right spot is in its diagnosis of the incentive structure that drives the economics profession and much of academia. It doesn't matter what you do and whether your work is of any relevance as long as you keep publishing in the right journals. And so it pays to derive all kinds of variations of existing models rather than to sit back and think what it all means. What have we learned? What does the model, paper, theory etc. add to our understanding? How does it fit in the greater scheme of things?

Thinking uses concepts and so for new economic THINKING you need new concepts. A concept is not a word, it is not a descriptive term. A concept is productive and creative. It allows one to move beyond what is given and think of new possibilities and new connections. I borrow this notion of a concept from French philosophers Deleuze and Guattari, but it is not that outlandish. This is from a recent book review by Paul Krugman and Robin Wells "It wasn't until John Maynard Keynes offered a theoretical explanation of how it is that economies come to be persistently depressed - an explanation that was informed by historical experience but went far beyond a simple description of past patterns - that economists could offer useful advice to policymakers about how to fight a slump".

So what are some of the novel concepts that have emerged in economics in recent years?

Institutions

This is a bit old hat, but I think the concept of institutions in economics is still branching out. This becomes clear once you read what economists think of as institutions. I think it's no accident that two of the most cited economists, Acemoglu and Shleifer, do a lot of research into institutions. Institutions provide the framework within which economic activities take place. Institutions are not given, they are constructed, they develop over time. But how?

Signalling

Michael Spence introduced the concept in his job market model, but it is a special case of a more general form of signalling in the sense of evolutionary biology. Merging both concepts may prove fruitful. The idea is that phenomena that appear irrational from an economic perspective are rational if one introduces signalling as an additional objective.

Imperfect Knowledge

This concept was introduced by Roman Frydman and Michael Goldberg in their book of the same title and some previous publications. I don't know whether it is a productive concept, whether other authors expand the ideas into other areas, whether it gives rise to a range of new models, insights and conclusions, but I like the sound of it.

Incomplete Information

I know this one is also a bit old hat, but it's still relevant because the implications of incomplete information for game theory and so on have not been fully worked out.

Asymmetric information

and the concepts that came out of it: adverse selection, screening, signalling. Again old hat, perhaps, but I'm not sure whether the concepts have been digested yet.

Endogenous growth

I'm adding this just as an example of incorporating into a model factors that for the sake of simplicity are traditionally taken as exogenous.

Randomized trials

I believe this is an important new methodology in economics.

Network effects and externalities

OK, so this is one of my own pet ideas. The indirect effects of innovations are still underestimated. The iPod and the iPhone app store created an entire ecosystem for accessories and applications. That's one thing. Innovations also bring about social change. The fact that people no longer have a car radio but just plug in their iPod or whatever means that thieves will seek another target, if one assumes that society has not changed so that there are no longer any thieves. The point is that if there are fewer car burglaries the demand for car windows and car insurance will decline. This is only a minor effect, but there may be a social shift taking place, the consequences of which may not be visible yet (more armed robberies of iPods and laptops?). The emergence of electronic payments, route planners, etc. also bring about changes that go beyond a mere replacement of a previous technology.

These are all existing concepts. The challenge is to create new ones.