I read something funny recently, sent to a mailing list associated with the Australian Stock Exchange, usually full of tips and advice for investors. Right there, in black and white, for all the share market investors to see, is a quick overview about why economic theories about markets are, by and large, no better than wishful thinking:
http://www.asx.com.au/resources/201105-why-markets-are-irrational.htm
This isn't news to anyone outside of the profession of economics and has been well known for quite some time. And yet, we still hear the lines about "letting the market sort it out", and how efficient using markets is - for EVERYTHING.
The article above sets out the fundamental reason why anything that economists come up with derived from their perfectly (or even semi-) rational agents maximising their utility (what does this mean in the real world, by the way? It's always taken by economists as, essentially, just money) just cannot be an accurate reflection of the real world.
My own background is in engineering, which is full of complex, non-linear mathematics. The models engineers use are, under the right conditions (which the engineer can usually control to some extent) reasonable reflections of the real-world. However, they always keep in mind the conditions under which the models apply, and the tolerances of how tightly they can fit reality. This is why, in general, buildings don't fall over, planes stay in the air and the electricity network doesn't blow up whenever someone in just the wrong place turns on a light!
Economics, on the other hand, doesn't seem to be burdened in this way. I must admit, first of all, that I am no expert in current economic theory, and that I only studied one economics at university because I had to to get my degree, and since that time I have eyed it very warily, but always assumed that I just don't understand the gory details well enough. However, whenever I have looked into the gory details, I have found them wanting. For example, when looking into how Game Theory is used in economics, my engineering training told me that here, again, were models of seemingly very limited scope and hence very limited usefulness in the real-world. However, it seems that these are the fundamental basis of economics.
The mathematics I was presented in University was hopelessly linear for systems that were obviously highly dependent on multiple variables in complex ways. Even more complex, non-linear mathematics (that might get closer to reality) wouldn't really work because, as has been noted many times before, economics deals with social systems which are characterised by complex dependencies and interactions between agents, many of whom have the same preferences at the same time. From a mathematical point-of-view, there is no "closed solution" to these systems. Worse than that, their behaviour is highly unpredictable and is driven by strong internal dynamics.
In engineering, we would seek to ensure that the system operated in a stable range, usually through negative feedback, and, especially, through avoiding positive feedback which characterises so much of the shenanigans we see in most "markets" these days. Big companies get bigger and bigger, the gap between rich people and poor people continues to widen, and speculative bubbles not only keep appearing, but seem to do so more and more frequently. The government's job should be to engineer the conditions for the system to operate with stable growth. The only aspect of economic policy that seems to be engineered for stabilising swings in the system (in Australia at least), is the macroeconomic setting of central bank exchange rates to keep inflation within controlled bands. It's a crude instrument, with quite a simple goal, but it seems to do the job. If only the government's microeconomic policies were engineered for stability as well!
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