‘The failure of Challenger is not the failure of physics’ is the appropriate analogy for Fed Chairman Ben Bernanke’s defense of neoclassical economics in the context of the recent financial crisis. He is shrewd when he states that economic science needs to do more to understand human behavior, which has become as much of a platitude as the Fed’s recourse in uncertainty in the face of policy failure.
This points to two possibilities: either the models are inadequate when the economic science he is defending is being applied by the Fed, burying what the Fed does not understand in the epsilon (the notation for white noise or Knightian uncertainty) at the end of the econometric equations or economic science itself is inadequate if policy failure is indeed, as the Fed almost always tries to explain, not a failure of risk management but uncertainty, using the two concepts synonymously and interchangeably with little intellectual rigor or discipline. Surprisingly, it is always a failure of risk management for Wall Street and uncertainty for the Fed when its policies fail. Little is said about the academic dogmas that shape Fed policy such as for example, “[sic] the Fed does not make industrial policy.” Does it really matter whether fiscal policy under budget deficits makes industrial policy or the Fed, especially under expansionary monetary policy?
Bernanke is correct in that the text book causes of market failure indeed apply to the current crisis. But the pathologies of neoclassical economics go beyond the text book causes of market failure. They cannot be addressed by trying to understand human behavior within the neoclassical paradigm. Economics, both capitalist and marxist must, more fundamentally, drop the dialectical materialist notion of homo economicus: that economic behavior is human behavior.
Attempts to fit all human behavior into some kind of an equilibrium between a downward sloping demand curve and an upward sloping supply curve is the fallacy. For example, diminishing marginal utility does not apply to knowledge. If it does not, one-half of the U.S economy cannot be explained by neoclassical economics as a science. The equilibrium price of a service then becomes arbitrary. The fabrication of scarcity of knowledge in competitive markets through its protection by firms leads to asymmetries which in turn lead to market failure -a seminal aspect of financial innovation that led to this crisis.
Dialectical materialism, whatever the system of economic organization, works for physics. But neoclassical economics cannot be defended as it is because it is not defensible until physics can explain biology.