A central axiom of orthodox economics is that scarcity underpins economic activity as individuals battle to meet needs in a world of limited resources. Another axiom is that individuals will rationally maximize their own utility through obtaining more information of risks.
In this short article, I explore how these axioms were found wanting during the recent financial crisis. It is not, obviously, the first time these axioms have been questioned. Nor, of course, will it be the last time that widespread knowledge of the limitations of economic axioms will be ignored.
Which is my main point. What’s surprising about the financial crisis is less that it happened – people had been predicting something like it for years. What’s surprising is how easily economists have withstood the exposure of flaws in their theories. Looked at closely, it becomes apparent that the chief tactic for ignoring limitations has been just that: simply ignoring limitations.
Telegenic economists have become superstars for publicly berating the discipline’s limitations, but quietly, behind the scenes, whole cadres of economists quietly persist in teaching and re-teaching methods that have been questioned or wholly debunked for years.
On one hand, nothing is new about the deliberate ignorance of inconvenient facts. As the sociologist Robert Merton pointed out, individual scientists routinely ignore new and old information in order to impress on others the novelty of their own discoveries. He called it “citation amnesia.” Auguste Comte went as far as to follow self-prescribed bouts of “cerebral hygiene” in the name of science, deliberately not reading more material when he was felt he was on to something new.
The value of ignorance
We’re good, in the social sciences, at knowing what not to know. We’re less good at admitting that fact. Below, I unpack this problem through examining an underappreciated economic asset: ignorance itself. I suggest that the deliberate effort to harness ignorance has been central to perhaps the most curious aspect of the financial crisis: how the very rich got even richer from exploiting a crisis which they purport no one could have seen coming. Rarely has incomprehension proved so lucrative – something perplexing until we stop seeing incomprehension and ignorance as liabilities and see them for that they are: useful strategies of action.
To make my case I’ll draw on a somewhat unlikely source: Georges Bataille, the 20th-century French novelist and social theorist best known for erotic novels such as Story of the Eye and for once volunteering – to no avail – to serve as a the first sacrificial victim of Acéphale, a French literary magazine and secret society preoccupied with human sacrifice.
Like a terrifying extreme version of Fight Club, each founding member of Acéphale offered to sacrifice their life for the society. None would act as executioner. An indemnity was offered for an executioner; none was found. Acéphale was dissolved before WWII. Bataille devoted himself to anti-Nazi writings and French resistance efforts. After the war Bataille turned to a focus on economics. He published his opus, The Accursed Share, in 1949.
As the historian Stuart Kendall writes, he was at once circumspect and optimistic about its reception, recognizing that it encompassed many disciplines in brief and none in depth. Sociology, economics, anthropology were mined at will. He secretly thought that it might earn him a Nobel Prize in economics. Unsurprisingly it did not. One-time sacrificial hopefuls are not the mainstay of the dismal science. Never a subtle writer, Bataille proclaimed to have accomplished a Copernican transformation in economics. His findings compelled, in his view, an “overturning of economic principles—the overturning of the ethics that grounds them.”
First, he suggested that economics wrongly emphasizes the study of scarcity over what he terms the “accursed share” – abundant wealth that threatens to destroy the systems that had produced it. Second, economics, and the social sciences in general, have underestimated the value of “nonknowledge” in social life.
Bataille’s relevance is increasingly evident today. Since the financial crisis of the late 2000s, most analyses have placed the failure of markets on a lack of information: traders lacked the skills to interpret complex algorithms; regulators lacked awareness of the risks banks were taking with capital reserves. Few analyses have explored the usefulness of those limits to stakeholders who had something to gain from purporting the crisis was unperceivable or understandable until it happened – or even after it happened.
Ignorance or liability?
During the financial crisis, ignorance had a triple usefulness. First, widespread “social silence,” in Gillian Tett’s words, enabled many stakeholders to keep profiting from the exchange of derivatives even after risks were widely evident.
Second, earlier silences were exploited in order to exonerate the actions of individuals claiming risks were impossible to detect in advance of the crisis. It was financially lucrative for stakeholders to claim ignorance both before and after the collapse.
Third, ignorance served as a form of ransom. When faced with collapse, the sheer unknown level of exposure of banks to their own toxic assets served as a trump card in convincing governments to rescue banks. Banks brandished their own ignorance like a white flag and a subtle threat. “Rescue me” or face consequences of unknown proportions.
As Michael Lewis writes in The Big Short, banks weren’t saved because, as individual institutions, they were critical to the global economy. They were saved because of their unknowable exposure to other stakeholders who would suffer as a result of the banks’ recklessness. Lewis quotes a hedge fund manager, Steve Eisman, on this problematic trump card of banks – the way they were able to leverage their own vulnerability in order to court cash injections. “There’s no limit to the risk in the market. A bank with a market capitalization of one billion dollars might have one trillion dollars’ worth of credit default swaps outstanding. No one knows how many there are! And no one knows where they are!”
The financial crisis of the late 2000s: will it perhaps be remembered as a story of the financial triumph of ignorance? Given how deftly banks were able to capitalize on their own myopia, is it possible that new axioms of economic theory will emerge, challenging the durability of ‘Homo economicus,’ an entity that, or so the theory goes, thrives on new information in order to maximize his utility? Will the ability to know as little as possible about a phenomenon be recognized for what it is: an indemnity against legal responsibility? It’s not likely that orthodox, neoclassical economics will change anytime soon. Although it’s impossible to determine the long-term impact of the financial crisis on economic scholarship in years to come, past precedents suggest that the usefulness of ignorance as an asset will continue to be ignored even as ignorance is actively mobilized.
On the one hand, orthodox economic perspectives have rarely seemed more fragile as writing from heterodox scholars such as Steve Keen’s Debunking Economics and Rod Hill and Tony Myatt’s The Economics Anti-Textbook reaches more undergraduates. On the other hand, as heterodox economists have long pointed out, the ease with which neoclassical scholars have managed to ignore challenges in the past suggests that a Kuhnian paradigm shift in economics won’t happen anytime soon – regardless of how much it may be needed.
Over a decade ago the economist Herb Thompson made this point in an article about how neoclassical economists had managed to deflect, for decades, evidence that many of their theories were wrong. They simply master indifference to that evidence. Challenges to supply and demand theory; the difficulty in measuring capital [pdf]; the fact that markets rarely, if ever, are “perfectly efficient.” All ignored. They’re simply untaught. Many undergraduates graduate without learning all of this counter-evidence. As Thompson puts it:
"Students and many of their preceptors, do not know that they do not know that capital cannot be measured; that utility is metaphysical; that optimisation is non-falsifiable; that capitalism is inherently unstable; or that, as Ricardo discovered, when we say 'supply and demand' we are explaining nothing. The incentive remains not to find out; or at the very least, not to recognise the numerous serious-minded non-neoclassical economists who take all of the above for granted."
Knowledge is power, Francis Bacon famously suggested. But often, in academia and in business, it is not.
The abundance problem
As for scarcity, the tendency to emphasize it over abundance is not so much wrong as simply narrow-sighted. Of course individuals battle over scarce resources. Of course some things become more valuable the less of them there are. But what about the opposite? Particularly since the late-19th-century neoclassical shift away from classical political economy’s emphasis on understanding economic surpluses, abundance has received far less attention in economics than scarcity.
There are, of course, exceptions. Published in the 1950s, J.K. Galbraith’s The Affluent Society exhorted economists to better understand the problem of overproduction and conspicuous waste in the private sector. He called for a return to the main preoccupation of 18th-century classical economics – understanding the sources of wealth production – while avoiding the major flaw of many economists since: overestimating received wisdom. In Galbraith’s words, “the shortcomings of economics are not original error but uncorrected obsolescence.”
If the history of economics is something of a scarcity vs. abundance smackdown, abundance is making a comeback. Abundance had a good crisis. It’s getting harder for economists to keep ignoring what most people politely assumed might be relevant to them: the study of surplus wealth and its toll on the economy.
Photis Lysandrou suggests, for example, that an overlooked cause of the recent financial crisis was the fact that excessive wealth generated a need for greater risks in the first place. The crisis was rooted in abundant wealth facing storage problems.
As Lysandrou says, "the crux of the matter is that, as the proportion of profits that could be reinvested in production continued to fall in line with the widening gap in incomes, so was there a corresponding rise in the need for those surplus profits to find alternative forms of storage. It may at first seem that this need could easily have been met, but the opposite was actually the case."
You could argue demand for storage outpaced supply, hardly a new problem. But that doesn’t remove the problem of the sheer unknowable nature of how many toxic assets were generated as a result of surplus wealth requiring ever more sophisticated – and simultaneously unknowable or measurable – investment instruments.
R.H. Tawney once suggested that “what thoughtful rich people call the problem of poverty, thoughtful poor people call with equal justice the problem of riches.” Decades later the “problem of riches” – the problem of abundance – continues to be neglected as social scientists grapple with a persistent problem: how can we study the unknowable? And how can we know just how useful the unknowable is to people financially profiting from their own ignorance? Ignorance is a powerful asset precisely because it can’t be measured. And yet social scientists, by and large, have ignored this problem. We persist in the quaint belief that knowledge is more powerful than ignorance at our peril.