This paper seeks to analyse the effects on Economics of Research Assessment Systems, such as the Research Assessment Exercise (or RAE) which was carried out in the UK between 1986 and 2008. The paper begins by pointing out that, in the 2008 RAE, economics turned out to be the research area which was accorded the highest valuation of any subject in the UK, even though economists were then under attack for failing to predict the global financial crash which had occurred a few months earlier. One aim of the paper is to explain this economics anomaly in research assessment. The paper goes on to point out a key difference between economics and the natural sciences. Most areas of the natural sciences are dominated for most of the time by a single, generally accepted, paradigm, whereas there are always in economics different schools of thought which have different and highly conflicting paradigms. Given this situation, it is argued that the effect of research assessment systems in economics is to strengthen the majority school in the subject (whatever that is), and weaken the minority schools. This conclusion is supported by empirical data collected by Frederic Lee for the UK. It is then shown that the greater the dominance of the majority school, the higher the overall valuation of the subject is likely to be, and this is used to explain the anomaly noted earlier. It is argued that research in economics flourishes better in a situation in which there are a number of different schools treated equally, than in one in which a single school dominates. The conclusion is that research assessment systems have a negative effect on research in economics and give misleading results. Instead of such systems, an attempt should be made to encourage pluralism in the subject.
The economic crisis has exposed shortcomings in standard economic theory and provided an impetus for new economic thinking. But the theoretical debate in the wake of the crisis has been unduly constrained by the terms of the mainstream approach to economic theory. Like any approach, it is characterised by a way of framing reality, giving meaning to terms and setting criteria for good argument. It also determines how any economic theory is understood, whether from the history of economic thought or from the contemporary literature. But there are other approaches to economics which would open up the field to a much wider range of possibilities for new economic thinking. Addressing the challenge that any reader bases her understanding on her own approach, the purpose of this paper is to attempt to explain what it means to consider different approaches. This is done by discussing two features of the financial crisis which pose particular problems for economic theory. These are the role of changing market sentiment in driving asset prices on the one hand and the breakdown of trust relationships in banking on the other (the moral hazard issue). We will see how these are addressed by mainstream theory and by alternative approaches. First, market sentiment is discussed within the mainstream rational-optimising framework, where risk is quantifiable, and compared with the Keynesian approach based on the general uncertainty of knowledge, where reason, evidence and sentiment are integrated. The moral hazard issue is then discussed in its mainstream form in terms of rational opportunism and in its institutionalist form in terms of the foundation of social relations (including relations between institutions) in trust. It is shown that different ways of approaching theorising in each case imply different policy measures. It is argued further that a deductive mathematical approach to analysis of market sentiment and trust is unduly limiting, and that a more pluralist approach would more fully address the issues.
High moments and transition probability provide new tools for diagnosing a financial crisis. Both calm and turbulent markets can be explained by the birth-death process for up-down price movements driven by identical agents.
The master equation approach in statistical mechanics and social dynamics derives the time-varying probability distribution for population dynamics. We calculate the transition probability from stock market indexes from open economic systems that is different from a Gaussian distribution from equilibrium physics in conservative systems. Market instability can be observed from dramatically increasing 3rd to 5th moments before and during the crisis and the changing shape of transition probability. Positive and negative feedback trading behavior can be revealed by the upper and lower curves in transition probability. There is a clear link between liberalization policy and market nonlinearity. The crisis condition for market breakdown can be found from the solution of the nonlinear birth-death process. Numerical estimation of a market turning point is close to the historical event of the U.S. 2008 financial crisis. The representative agent model of random walk and geometric Brownian motion in macro and finance theory does not provide any clue on the condition of a financial crisis. The sub-prime crisis in the U.S. indicates the limitation of a diversification strategy based on a mean-variance analysis. Historical lessons in recurrent financial crises demand a more general framework with endogenous instability and economic complexity, such as nonlinear interactions, non-stationary dynamics, and social interaction. Our general framework greatly extends the scope of equilibrium models in finance, which is a special case of a calm market in our nonlinear model. We obtain a unified picture of economic complexity with endogenous instability and market resilience (JEL G01, E32, C58)