The book opens with a foreword and preface of the new version which basically gave a summary of what had happen since the first publication in term of reception. The work was cherished by heterodox economist and sparked debate over the way of economics was taught as a subject. This was in light of the economic crash in 2008-09, which was not predicted by many ‘experts’.

The idea however was rejected by mainstream neo-classical economist due to the fact that it challenges the established theory.

David Orrell blamed the abused of mathematical models, used by bankers, analyst, and economist, not just the models cannot predict the crash, he argued that the model helped cause the crash. But he went further, not just the mathematical models were flawed, the fundamental theory in which we understand economy is plain wrong.

Orrell maintained that whilst economist based their economic law from reductionist model of Newtonian physics, humans are not like atoms, they are not rational and cannot be modelled. He is not alone on this, Ha Joon-Chang also maintains in his book that economics is not a science like physics.

But while Chang criticized free-market economics, Orrell went further and dispelled the fundamental ‘law’ of economics – the supply and demand theory. He insisted that the supply and demand curve, which was taught in every economic school, has never been proven empirically with real data, the curve is “like a unicorn, always drawn but never really seen”.

The problem with the curve is that it exists on ceteris paribus – other things held constant, but in real life, this was never the case, supply and demand always change and dance together. The danger of perceiving the concept as ‘law’ will have a severe consequence in real life, we will be searching (wasting our time) for a creature that is non-existent.

Orrell then pointed his gun to the ‘efficient market’ hypothesis which assume that people are rational motivate by profit, have access to market data, and independent in making decisions. This theory take root from atomic theory which equate individuals like a particle of atoms. He lamented that this is fundamentally wrong as human always did irrational things and they communicate, advocate, and influence others, to create a mathematical model out of individuals based on atomic theory will lead us to a catastrophic trap. This trap made IMF made a comment in 2007 that “world economy will have a robust growth in 2007 and 2008” before they eventually crashed.

He then cited evidence from the UK housing market, where people under constant pressure from advertisement to buy house and made profit through speculation. People buy houses more than they needed, to make profit. This creates a psychological pressure and induced others to follow suit, they did not act rationally, but emotionally fearing of missing out, and behave in “herd” behaviour. Obviously, you can’t make mathematical model from human emotions. The notion that market will regulate itself in mathematical precision is therefore highly unlikely and nowhere to be seen.

One of Orrell point is to make finance less efficient, this point was in common with the call made by economist, Ha Joon-Chang in his book about problem with capitalism. Orrell argued that by abolishing the Glass-Steagall Act which separate daily commercial bank with speculative investment bank make the financial system more integrated. Therefore, default is contagious, one failure can drag the whole system down. He called for re-compartmentalization of these banks, although it reduces efficiency, it introduced a control mechanism to limit failure. Another aspect that might save us in time of crisis is redundancy, in nature this can be observe on the extra kidney we carry, while in the economy, this mean that banks need to have limit to their gambling risk and hold extra reserve to survive the bad time.    

The economy is unstable according to Orrell, to elaborate this argument, he explained the banking system in the word of economist Hyman Minsky who contended that the borrower can be categorized to three, first the hedge, this is a regular borrower who can pay their principal and interest. Next, the speculative, who can only service his interest such as the mortgage borrower. Than the final one, the ponzi, who had a lot of hope, can only pay if the asset price continue to rise. As the debt continue to accumulate, it will eventually burst, starting with the ponzi, followed by the speculative, and finally dragging down the hedge – this will be the Minsky moment.

Financial system is not a natural system, we had a say and can better engineer them. Orrell suggest that we model them from the current extreme form which focussed on short-term profit towards a more normal ones which gave lesser profit but much more resilient from crashes, he then laid his suggestion on how to achieve this goal. One of them, is create a barrier by testing financial product to understand their risk before releasing them to market. Regulation, contended Orrell, will caused some inefficiency but it gave stability, he then poked the concept of the ‘invisible hand’ by saying that if we looked at our own hand, it is heavily regulated – from temperature to cell salinity – putting economist to shame.

Other interesting discussion in the book by Orrell is about the differences of government monetary policy between Milton Friedman and John Maynard Keynes. Whilst Friedman inherit the free-market ideology and anti-regulation propagated by the Chicago boys, Keynes expanded government involvement in the economy and advised the boosting of government spending during recession to compensate demand. He also took a punch on Friedman stating that its ironic he opposes government intervention but at the same time the Chicago boys sustained themselves in part by government grants.

Many of his argument do ring a bell, underlaying assumption in economics such as people are rational is somewhat laughable. Human are not computers, they are highly emotional, and because humans are the building block of the whole economy, the economy must be emotional, we can’t exclude the most important trait of human being, produced a model out of it and applied it to the real world.

But there is also an oxymoronic argument put forward in his book. In one of the chapters he tried to make a case that the economy is gendered, he even brought forward the concept of yin and yang claiming that the aggressive bet and speculation are attributed to male trait (female did not gamble?). But while trying to make his point, he took a sharp turn and wrote that ‘it would be terribly reductionist to blame…solely on people with a tendency to grow facial hair’. So which is it, is it really gendered or it is a reductionist assumption?

Current economic theory is not a science, Orrell contended, but rather an ideology peculiar to a certain period in history because it does not add up to the empirical data and made various assumption which does not hold true in real life situation. He went on outlining the similarity of the global economy with a ponzi scam by Bernie Madoff. Such similarities includes a complicated but plausible story, trust, incentives, a network of rich and powerful people, influence with regulators, illusion of growth, and an outdated machine (a price theory that said price is always right).

Orrell also called ethics to be included in the economic equation, as there are many aspect that will lead to harmful consequence if the whole decision was left to market to decide. For example, he asked if we leave resources such as oil for investment company such as pension fund to decide, why should they put a cap on production? Their motive is short term gain without consideration of long-term environment decays. These are the area that need to be addressed by ethics in the form of government intervention and regulation.

I do find one question fairly amusing. When he tried to make a case that other field of studies actually needed to construct new economic model, he asked a question ‘are philosophers in agreement that market can make ethical decision?’ This question, I think, is also an oxymoron. Philosophers were always in disagreement almost about everything between them.

Finally, concluding his book, he asked readers to confront every economist in their lives and observe their reaction. They can reply in denial, anger, depressed, or in good case, accepted the criticism and chartered a new path. For a change to happen, we need to acknowledge first that the problem exist.

This article is a review of the book ‘Economyths: 11 Ways Economics Gets it Wrong’ by David Orrell.

What was missing in the economic theory that lead to the financial crisis in 2008-09? This was the first question Drennan want to answer in this book. His thesis is that income inequality plays a role in the lead-up to the financial crisis by maintaining consumption through surging household debt. The second question he asks was ‘Why the economist get it wrong?’. Drennan’s answer to the second question is that the consumption theory of neo-classical economics does not include income distribution to their economic theory.

To prove his points, Drennan brought forward econometric evidence to link income inequality with the financial crisis. He also used various set of data to show that many people resort to debt to maintain their consumption, meaning that people borrow more money to buy the necessities to maintain their lifestyle. He also present historical data as evidence to show that the 2008-09 crisis is not something new and has happen before.

Drennan also noted that the two feature that were on the rise leading to financial crash were the stagnant growth of income and income inequality – although this two do not necessarily occur together. Although Drennan try to back his argument with data and statistics, layman reader will not find this useful, understandable, and almost definitely lost in the process.

What are the possible causes of rising income inequality? Asked Drennan. Economist pointed out that one of the candidates is globalization, but he cast doubt to this theory as other countries such as Japan, Germany, and France were exposed with the same globalization forces but does not produce higher income inequality. Other candidate favoured by economist to explain income inequality is skill-biased technological change (SBTC). This include higher order specialization, for example box mover can learn to operate forklift easily, but factory worker might have problems changing their career to higher-order specialization such as a programmer. Some economist listed SBTC as the cause of the rising income inequality.

But all these candidates do not give the whole picture. The more compelling cause, is the institutional structure. Drennan noted that as the economy turn from manufacturing to service economy, the labor union diminished. This is because the service sector does not have a strong labor union traditionally. The structure of the law also plays important roles in containing the labor union force, without them worker have a lower protection and had to accept lower wages as they don’t have any bargaining power.

Then there is government intervention. Contrary to free-market ideology, that income stabilize in its current level due to rigorous market forces, there are many government legislation interferences that favors the rich and enlarge the income inequality gap. Among the law includes treatment to corporate stock option award, access to bankruptcy, copyright and patent protection, to name a few. Various conservative think-tanks served as an advocacy lobby to ensure government keep policies for the benefit of the rich, their objective is rent-seeking – spending money not on production of product or service but to take advantage and enlarge their own economic pie at the expense of someone else’s share.

After presenting his theoretical background, Drennan continue with the data to back his theory. Although he emphasized in the introduction that the role of the data presentation is ‘not to obscure the fact’, he did just that for a layman reader as they lost in the jargon terms and various graph. Drennan drew from Federal Reserve’s data that there are a huge build-up of debt-to-income ratio for the bottom 95 percent whilst consumption remains more or less the same, which means that consumer are shifting to debt to maintain their consumption, this lead to financial burst eventually. These consumptions include shelter, health care, and education which are a necessary expenditure which cannot be postponed, such as taking a vacation trip.

In the book, Drennan also help explain economic principle such as the Pareto efficiency principle which stated that “any change that make one people better off, without making any other worse off, is an improvement”. This principle is a fundamental tenet of neoclassical economics, which describe the gain of top 1% of the income distribution as Pareto efficient. This is one reason why economist turn away from income inequality.

Other theory, such as Kuznets’s inverted-U hypothesis, also made economist less worry on the income inequality and its effect. Drawing from various historical data from numerous countries, Kuznets argued that the economic shift from agriculture to industrialization will lead to the rise of income inequality for some time, but as countries develop, democracy expands and more protection were given to labor causing the inequality to fall back. He also discussed Arthur Okun’s tradeoff theory although Okun provided no strong evidence.

In analyzing the data, Drennan also drew his criticism towards Milton Friedman model for theory of consumption, noting that the theory does not true for the period 1984-2007 and for the early twentieth century. He went further to underline the basic flaw of Friedman, Modigliani, and Brumberg’s model which become the mainstream theory for consumption, the models devoid of motive and proclivities, whereas in real life human behavior play an important role in their daily choices and consumption.

In his final chapter Drennan drew attention that this crash has happen before, and in his conclusion, he argue for the need to drop traditional economic theory that did not stood the empirical test from the data. Unless we take into account other element such as ‘behavior’ in our economic theory, we will be chasing unrealistic economic development using unrealistic theory.

If you have read ‘Freakonomics’ by Dubner & Levitt and searching for a kind of book that provide the same unconventional, myth-busting analysis on economics occurrence, this book is definitely it!

Written in layman term without heavy technical terms, Chang open the access gate to wide range of ordinary readers about the working of economics. As he himself noted in the introduction, you don’t need to be an economist to understand his book. He lay out his aim explicitly on what he intended to do, which is to exposed free-market capitalism, he still believes that capitalism is the best economic system, his problem lay on specific type of capitalism which has dominated the world economy which is the free-market capitalism.

Chang argues that free market does not exist. Every market has rules, boundaries, and restriction which govern them. As we accept all these rules unconditionally, we fail to see them as market restriction. Labor market has many restrictions, you can’t hire child laborer this day. Also, most countries have immigration control to protect local labor market, and to hold the wage standard from falling. All these restrictions were not been put based on sound economic reason, they are political decisions. That is why Chang argues that the free-marketeer was as political as the one who opposed them. 

Workers in rich countries doing the same job are paid more compared to their counterpart in poor countries. Why is this so? It is not because of the people in rich countries are more productive, brilliant, or creative. It is precisely because of the immigration control that retain the wage standard. The gap also presented not because individual in rich countries are highly educated, it is because they have better technologies, better institutions, and better infrastructure. This line of analysis is consistent with what was presented by Turkish American economist, Daron Acemoglu and British political scientist, James A. Robinson in their famous book ‘Why Nations Fail’.

Chang discussed about Alexander Hamilton, the first Treasury Secretary and the architect of the modern American economic system. Hamilton laid out protectionism strategy to protect American industries ‘in their infancy’. Have he come up with the same policy that develop America then today, Chang argued that he will be criticized by US Treasury Department and denied loan by IMF and World Bank. Chang brilliantly argued that developed countries forced market liberalization on developing countries, whilst they themselves used protectionism policy when they were developing. In other words, the rich countries said to poor countries “do what we say not as we did”.

Why do European migrated to the U.S. in 1880-1914? – asked Chang. He argued that the New World lack of feudal legacy which led to higher social mobility compared to the Old World. The U.S. also had a massive tract of land and a shortage of labour, thus wages are three to four time higher than Europe. But he argued, today American does not have the highest living standards. They worked longer hours and had inferior healthcare system. Average income also did not gave an accurate living standard in the U.S. as she had a bigger unequal income distribution, with bigger size of underclass.

Chang also criticized many economist approaches on the question of Africa’s poverty. Chang argued that  rather than blaming free-market policy failure to develop Africa, free-market economist shift the blame towards Africa’s geography, climate, history, demography and ‘resource curse’. While all these factors are not all irrelevant, the outcome can change, for example, there are many resource-rich countries that were well developed. Some factors like geography and history cannot solve the question as they can’t be change. The most important factor, Chang noted, is policy. Policies can be change when they failed, especially and evidently in Africa.

On trickle-down economics, Chang brought evidence that the policy failed to deliver its promise and failed to accelerate growth. The book also discussed the failure of micro-credit, as a system to finance small enterprise and lift people out of poverty. The idea was famously attributed to the economist who won a Nobel Peace Prize, Muhammad Yunus and his Grameen Bank. Factors for the micro-credit failure includes the used of the funding for consumption, not for their initial intended purpose. While some used the funding for their business, the business failed to develop and re-create itself once their market was overcrowded and profit fell.

One of the most profound idea I found in the book is on how we limit our choices to make decision. Chang brought this idea base on Herbert Simon’s thought. Human cannot easily make decision when they were flooded with seas of information. That is why we develop routine, although they might be a better way to do things, people stick to routine so that they don’t have to make too many decisions. Market, Chang argued, were far more complex with billions of product, people, and companies. So, government intervention using regulations is justified, to limit the uncertainties and risk in the market, so that we can make a more rational and easier decisions.

Switzerland is one of the top few richest and most industrialized countries, but it is by far the lowest in term of university enrollment. Chang argued that excessive education does not lead to more productive economy. Subject such as history and biology does not much needed for average factory workers. He argued that knowledge-based economy is an exaggeration with many rich countries still rely on their manufacturing output, so, developing countries cannot skip manufacturing phase of the economic development.

Equality is not enough, said Chang. It does not make any sense if a rich boy and poor boy given the same opportunity to attend school, but the poor need to compete with a hungry stomach. So, its not just the opportunity to enter competition needs to be given, but the condition must be equalized.

His logic about big government is a compelling one. Big government he argued, make the economy more dynamic. When basic income was guaranteed, people will not be afraid of changing jobs from sunset industries into sunrise industries. When government provide re-skilling opportunities, people can more easily shifted from less productive industry into more productive one. People don’t afraid of loosing job because they know it will not be the end of the world, they have a safety net, and can move on.

Overall, the book is very rich with myth busting, facts, case studies, jokes, that will transform your understanding about economics. You know that the system is broken, but it is broken for a wrong reason and can be fix. The fix, as argued by professor Chang in his concluding remark, will not be comfortable or fair, but it is needed to give a chance for billions of people, and alleviate them from poverty.