Scientific American Magazine - March
17, 2008


The Economist Has No Clothes


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

http://www.sciam.com/article.cfm?id=the-economist-has-no-clothes&sc=rss


By Robert Nadeau

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is clear that neoclassical economics has also become outdated.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.

The physical theory that the creators of neoclassical economics used as
a template was conceived in response to the inability of Newtonian
physics to account for the phenomena of heat, light and electricity. In
1847 German physicist Hermann von Helmholtz formulated the conservation
of energy principle and postulated the existence of a field of conserved
energy that fills all space and unifies these phenomena. Later in the
century James Maxwell, Ludwig Boltzmann and other physicists devised
better explanations for electromagnetism and thermodynamics, but in the
meantime, the economists had borrowed and altered Helmholtz’s equations.

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.

If the environmental crisis did not exist, the fact that neoclassical
economic theory provides a coherent basis for managing economic
activities in market systems could be viewed as sufficient justification
for its widespread applications. But because the crisis does exist, this
theory can no longer be regarded as useful even in pragmatic or
utilitarian terms because it fails to meet what must now be viewed as a
fundamental requirement of any economic theory—the extent to which this
theory allows economic activities to be coordinated in environmentally
responsible ways on a worldwide scale. 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. It is
imperative that economists devise new theories that will take all the
realities of our global system into account.