The State of Economics
Robert Skidelsky
INET Conference | Friday, September 06, 2013

Economists like to believe that theory drives policy. Bad policy is the result of bad theory; the remedy for bad policy is better theory. Keynes was squarely in this tradition. He remarked that, “practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” He believed that the power of ideas would, sooner or later, overcome the power of vested interests. Perhaps this is true in the long run. Vested interests require the legitimation of ideas; this legitimating function gives ideas their influence on policy. But in the short run, the power of vested interests - the power of power - can rule policy with minimal help from theory.
The policy response to the recent financial crisis offers a perfect case study. The initial 'Keynesian' response was driven by political necessity: it was much too politically fraught to risk a collapse into another Great Depression. But the rescue operations then undertaken, left governments vulnerable to the assault of the bond markets. This, particularly in the eurozone, has driven the policy of fiscal austerity. With fiscal policy disabled, the only recovery policy left was printing money. In these policy responses to different phases of the crisis, the influence of theory was negligible. The theory supporting fiscal austerity in a slump is virtually non-existent; no one knew what the effect of quantitative easing would be. It was lauded by business interests as a way of shrinking the state without choking off recovery.
Theory will doubtless catch up with these developments; but on present evidence it is very much a lagging indicator.