In 2007 Alan Greenspan said that economists' forecasts are no better than anyone else's. He added that econometrics is no science. Why?
The underlying reason is the nature of economic models. First, they assume economic agents to be mostly rational; secondly and more importantly, they assume that the rational agent maximises calculable outcomes - the assumption of the homo oeconomicus. Since Adam Smith economists have understood the economic system as a vast machine. That implies it should be predictable, but on the evidence it manifestly is not.
Is it even possible to forecast human action? Sometimes it is, when one is dealing with habitual behaviour. But non-habitual behaviour, including innovation, is not at all predictable. Classical economics does not explain how innovation comes about, nor the implications of this for economic theory and calculation.
Innovation is a creative process. A product or process is creative if it is both new and valuable.
Creative activity is hard work. It involves the production of and selection from many ideas and prototypes. Most are discarded. It is emotionally and personally difficult and relies greatly on self-motivation. The grounds on which ideas are produced and selected depend on their worth from the point of view of ethics, aesthetics, technology, and many individual psychological factors, all sifted by experience and ability.
Today, the market is where the economic value of new processes is assessed. The idea that rational calculation in pursuit of a defined end is the primary means by which creative processes see the light of day is simply a backwards extrapolation from the determination of value by means of prices and money that goes on in markets. It's a notion that has been applied to a huge variety of social phenomena, naturally enough business and commerce, but also ethics and religion.
At the enterprise level, we see a tension between economic logic, which is ultimately about control, and the need for innovation, which requires freedom within a secure, non-competitive environment. Companies that are too controlling (especially of cost) are likely to stifle innovation.
This applies at the macro-economic level too. The market does not elicit creativity; it is only a valuation process. In fact, competition can hinder creative activity, often through different kind of creativity aimed at influencing market behaviour through PR, advertising, or speculation, as well as through the imaginative bending of rules and 'creative accounting.'
Wilhelm Röpke once said that the market presupposes the moral resources that it cannot itself generate. This is a fundamental insight. I would add that the market also presupposes the creative resources that it cannot itself generate. Because product innovations are closely linked to market evaluation there is a tendency to overlook the 'soft factors' in the urge to plan, produce, and control these resources - which is impossible.
It is logically impossible to forecast a new idea. There is therefore no identifiable cause of creativity; the source of creative ideas is hidden. But even if we can't say which innovation will prove to be successful, we can expect that the probability of success will increase, the more new ideas we have. Creativity requires superfluity and space for failure. It is counter-productive to try to control creativity using financial disciplines, because the measure of creativity is not its material success, but its capacity to generate further creative innovation.
Creativity is subject to non-economic competition. The drive to be better, cleverer, or faster than someone else is motivating and exciting and feeds our self-esteem in a way similar to fulfilment through team work. This competition or struggle of ideas needs a space. That cannot be where ideas have already been evaluated within a system subject to financial control - a market.
Finally, A's creativity is B's uncertainty. Innovation leads to uncertainty, whether in a conversation when someone is caught short by a new thought or in commerce when a new product threatens incumbents. Uncertainty and fear are the flip-side of creativity, and the reaction is not always creative. In order to re-establish security, one either tries to copy the innovator's creativity or one tries to obstruct it, for example by using a market-dominant position.
In summary, economic phenomena cannot be understood only by means of mechanistic or probabilistic models, as is shown by the repeated failure of these to predict serious crashes (e.g. 1987, 1998, 2000, 2007). For as long as economies incorporate creative processes there will be unexpected outcomes. Moreover, only economies that give room to creativity will reap its long-term benefits in terms of growth and progress. In other words, an economy founded on the logic of the homo oeconomicus is heading in the wrong direction. As long as we continue to see failure, we might hope that there is an innovative process behind it that will be truly valuable
Summarised from Karl-Heinz Brodbeck:
Wirtschaft als kreativer Prozess - wie ein weicher Faktor harte
Tatsachen schafft (2008)
Original full article here.