What Went Wrong with the Economics

In the wake of financial calamity, the reputation of economics as a discipline established over many decades has taken a beating. The notion that free markets would regulate themselves and lead to a prosperous society now seems to be far-fetched. Having established a large number of fancy and esoteric theories, economists still failed to foresee the financial crisis. People can't help but ask: what went wrong with economics?

Modern economics is often criticized for their unrealistic assumption that people are act in rational ways. Stemming from this assumption, the theory of the efficient market has dominated economics for decades. Based on this theory, a large amount of mathematic models were built. Wall Street ransacked the best universities for game theorists, physicists, and statisticians to evaluate different choices. Many new and fashionable economic funds were created, and all kinds of creative new instruments were available in the financial market. People put their money into these funds, though none of them really understood how they work. In fact, this was exactly why these financial economists looked ever more trustworthy.

Every theory comes with skepticism attached. Economists were hardly naïve believers in market efficiency. Concentrating on the irrational action, behavioral economics, a newly prominent field, has gained people's attention quickly and one of its leading proponents has won a Nobel Prize for “having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” With the help of this theory, people have begun to understand how human beings' irrationality gives limitation to market efficeincy.

There were caveats aplenty. People knew the notion of the efficient markets is imperfect and cannot be completely relied upon. And people have also been aware of ridiculous assumptions of valuing mortgage derivatives on the basis that house prices would always rise. Moreover, some have warned that the incentives may encourage the fund managers to take higher risks. However, putting profit before consceince, those “smart guys” in the Wall Street chose to ignore these glaring warnings. Being too fixated on chasing profit and too cavalier about asset bubbles, they putted aside delicacies and overlooked the impending danger.

No matter how closely resembles physics or other natural sciences, economics, without doubt, is a social science. In physics, lack of due caution may cause failure of an experiment; while in financial markets, it may result in bankruptcies, financial crises, global disasters and human suffering. It might be incomplete and deficient in many areas, but economics did not go wrong. It was people’s greed that twisted the economic rules and left the world in turmoil, and now it is time to pay the price .