A remarkable feature of the unprecedented financial crisis that erupted in September 2008 is the doctrinal shift among world leaders. The market is no longer seen as the solution to every problem. The state has to step in to save capitalism. The US Republican Party had been the champion of free markets and minimal state intervention, yet President George W. Bush became the exponent of a huge state bale-out of the banks with a massive extension of state ownership within the financial system.
Alan Greenspan, former chairman of the US Federal Reserve, belatedly declared that he had ‘made a mistake in presuming that the self-interest of organizations, specifically banks’ would protect ‘shareholders and equity in the firms’. He had ‘discovered a flaw in the model’ of liberalisation and self-regulation (Guardian, 24 October 2008).
All UK Prime Ministers since Margaret Thatcher have promoted market liberalisation. Yet everything changed with the global financial crisis. Prime Minister Gordon Brown’s package of measures including partial state ownership of banks became the global model. On 19 October 2008 the Chancellor of the Exchequer Alistair Darling announced massive government spending to kick-start the British economy. He said that the economic thinking of John Maynard Keynes was coming back into vogue.

Big banks are failing, bailouts measured in hundreds of billions of dollars are not nearly enough, jobs are vanishing, mortgages and retirement savings are turning to dust. Didn’t economic theory promise us that markets would behave better than this? Even the most ardent defenders of private enterprise are embarrassed by recent events: in the words of arch-conservative columnist William Kristol,
There’s nothing conservative about letting free markets degenerate into something close to Karl Marx’s vision of an atomizing, irresponsible and self-devouring capitalism.
So what does the current wreckage of the global financial system tell us about the theoretical virtues of the market economy?
Competitive markets are traditionally said to offer a framework in which, in the memorable words of the movie Wall Street, “greed is good.” Adam Smith’s parable of the invisible hand, the founding metaphor of modern economics, explains why the attempt by butchers, bakers and the like to increase their own individual incomes should turn out to promote the common good. The same notion, restated in rigorous and esoteric mathematics, is enshrined in general equilibrium theory, one of the crowning accomplishments of twentieth-century economics. Under a long list of often unrealistic assumptions, free markets have been proved to allow an ideal outcome – meaning that the market outcome is “Pareto optimal,” i.e. there is no way to improve someone’s lot without making someone else worse off.

I argue that the current financial crisis highlights the crucial need of a change of mindset in economics and financial engineering, that should move away from dogmatic axioms and focus more on data, orders of magnitudes, and plausible, albeit non rigorous, arguments.
Compared to physics, it seems fair to say that the quantitative success of the economic sciences is disappointing. Rockets fly to the moon, energy is extracted from minute changes of atomic mass without major havoc, global positioning satellites help millions of people to find their way home. What is the flagship achievement of economics, apart from its recurrent inability to predict and avert crises, including the current worldwide credit crunch?
...Classical economics is built on very strong assumptions that quickly become axioms: the rationality of economic agents, the invisible hand and market efficiency, etc. An economist once told me, to my bewilderment: These concepts are so strong that they supersede any empirical observation. As Robert Nelson argued in his book, Economics as Religion, the marketplace has been deified...

The communications gap between mainstream economists and the general public reaches its extreme in the realm of mathematical theorizing. Agents in the everyday world may (or may not) act as theory predicts without being even remotely aware of theory. But these same agents, regardless of background, do often use much of the language of economists. My goal in this paper will be to offer a preliminary exploration into the changing importance of certain major economic words over the last century.
“Competition” and its many derivatives will form the centerpiece of the paper. We clearly have an instance here of a word dear to mainstream economists that is at the same time a regular part of most adult vocabularies in the English speaking world. We also have a word that shows up in many different contexts. Firms and markets may be competitive, but so may be sports teams, determined personalities, and institutions usually outside the realm of “the economy.”