Michael Fry: Dismal results of dismal science

It is just the same with the global economy now, not to speak of any national economy within it. The soothsayer's stock-in-trade of astrological mumbo-jumbo can be compared to the hugely elaborate mathematical models of academic and financial experts. The models did not let many of them see the catastrophic credit crunch creep up on us. Foresight was by and large reserved to a few free spirits who preferred to think things out all on their own, using their common sense.

Today the profession of economists is left with little useful to say about the planet's predicament. With all the signs once again so alarming this August, lesser beings might validly conclude it is best to shut their ears to the words of the experts and do what seems immediately right to them: such as refuse to spend anything except what they must, since this year or next year they may face a personal disaster. This is why recession stretches ahead as far as anybody can see, and steadily takes its toll on one country after the next.

The failure of political economy as a discipline (I do not think we can any longer say science) stretches right across its spectrum. Back in the depths of the slump in the 1930s, it was John Maynard Keynes that proposed governments should stop trying to balance their budgets and instead boost their economies by something previously regarded as unthinkable: allowing the state's expenditure to rise above what could be financed from its taxation. The Second World War caused all the old economic principles to be dumped anyway, as every combatant country spent what it had to in order to win - or, if it lost, afterwards spent the money all over again to rise from the ruins. And indeed, general prosperity followed.

All the same, by the 1970s Keynesian deficit financing was causing more problems than it solved, which prompted its replacement by a new monetarist orthodoxy. Keynesians continue as critics of that, without ever managing to restore their old certainties, even to themselves. They are still around today, for example in Britain claiming that the cuts go too far and too fast. The necessity of cuts is not denied, however, and this in the depths of recession: Keynes must be turning in his grave. The substance of any policy often seems scarcely to matter, only whether the financial markets will like it.

Strictly speaking, monetarism was a doctrine much narrower in scope, confined to the role of government in creating money: if the government got that right, it had less need to do anything else. So a general deregulation could follow. In Britain, financial deregulation in particular restored for a globalising economy the prominence that the old, gentlemanly City of London had lost. Slick Cockney traders turned the making of money into an activity more important than any mere production of goods by horny-handed sons of toil in the provinces. Again, this appeared to be working fine for a couple of decades: many countries got richer and Britain got richer than most, while financiers enriched themselves more than the rest of the Brits put together.

Today, however, monetarism lies flat out in the same prostrate, bleeding, barely conscious condition as Keynesianism. The British government, among others, prints money as fast as it can in the hope that people will spend it - but nobody does, so it piles up in the now loss-making banks, fuelling the preserved privileges of bankrupt bankers. Interest rates, during the glory days of Thatcherism almost the main instrument of economic policy, no longer appear to work, so we are content to leave them hovering hardly above zero. In monetarist terms, this all adds up to the formula for a great inflation, yet in Britain we only have a small inflation, hoping nobody will notice while other nations stagger on in a much worse state.

Altogether, then, neither of the two dominant currents of modern economic analysis on which we have long relied offers much guidance as to where we are or where we need to go. The dismal science seems, something over 200 years after Adam Smith founded it, to be entirely played out.

Since economists have failed in foretelling the future, perhaps as a historian I might recommend to them the virtues of hindsight. It strikes me that the decay of the dismal science set in a long time ago. Smith used to set out his arguments in words; words which we can still easily read today and understand, or at least argue coherently about. From the mid-19th century, economics began to turn mathematical. In the 20th century, it became almost wholly so, and indeed steadily more impenetrable to anybody not versed in higher mathematics.

In this form economics could easily be transferred to computers. At length these might, among other things, be programmed to intervene on the markets through automatic triggers free of human control. Or if anybody could exert an influence, it was hedge fund managers performing operations so technically complex that nobody else could understand them; certainly not the poor fools appointed by clueless politicians to regulate the whole business.In Edinburgh in 1990, I was there in the audience when Wassily Leontief, the late Nobel Prize winner from Harvard University, warned of the danger that economics had turned into a branch of knowledge so obsessed with mathematical virtuosity that it was in danger of losing touch with the real world. Two decades later, the prophecy has been fulfilled. On the one hand we have hundreds of universities with departments of economics full of professors, researchers and students practising and learning mathematical doctrines and techniques complete and coherent in themselves. And then we have a global economy in freefall which none of those doctrines or techniques actually affects. Divorce between the science and its subject is complete.

Any hope then? Well, there is another school of economics (called Austrian by convention, though it has little to do with present-day Austria) which rejects the idea this has to be a mathematical discipline to produce valid outcomes. As such, it has drawn down on itself scorn and contempt from across the conventional spectrum of economists, from Keynes to Milton Friedman. Instead of mathematics it uses readily grasped axioms which can be tried and tested on the ever-changing conditions of the real world, without necessarily expecting a constant result.

For example: if you vastly expand credit, you will debase the quality of the consequent debt. If you go on and on and on despite all the dangers, the banks which are the intermediaries of the credit and debt will collapse. QED, I think we can say looking round us.

And what do Austrian economists say about the conditions we face at this moment? Basically that the mess will take years to sort out, and the best that governments can do in the short term is to stop making the same old mistakes.

Unfortunately, that is just what governments carry on doing. Economics may have ceased to be a science, but it has got no less dismal.