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Business

Reading the crystal ball: Economics faces credibility crisis

Current economic forecasts expect the German economy to grow at 1.8 percent next year. It's an estimate some economists say is complete nonsense, one based on outdated models out of touch with the real world.

Ever since the outbreak of the global economic and financial crisis in 2008, economists around the world have been facing the stern question of why they haven't been able to warn politicians and the public alike of the doom unfolding.

In the absence of any satisfactory answer, some economists such as Frank Riedel have begun to question the model on which economics bases its assumptions and predictions.

Current economic models were failing reality, the director of the Center for Mathematical Economics in Bielefeld, wrote in his latest book titled “Blaming the Economists.” The message of his clear-cut analysis of the crisis is that economic predictions lack any scientific foundations.

Using Germany as an example, Riedel told DW that it was impossible to take the individual behavior of all of the country's about 40 million households and 2 million businesses into account when making predictions about the future. Therefore economists would resort to a representative model household and a model business for the undertaking. Using this as a vehicle, he said, was perhaps sufficient to take a philosophical look at economics, but completely inappropriate to calculate, for example, future economic growth.

The myth of ‘homo economicus'

At the centre of current economic models was the assumption that the decisions of all economic players were based on rational behavior, Riedel said. If humans were acting like "homo economicus" - as this type of ideal human being is denoted in economic science - stock markets would never crash, he added.

Frank Riedel

Economist Frank Riedel believes standard economic models are substantially flawed.

Moreover, financial markets were generally ignored in most mathematical and statistical equations on grounds that economists didn't consider them important for the real economy.

“If models ignore financial markets, they are unable to predict a financial crisis, which, in turn, will have an unpredictable effect on economic growth,” Riedel told DW.

Current economic developments were a striking example of how uncertainty about the banking sector and a lack of trust massively affected the flow of credit and investment, and subsequently growth in the labor and goods markets.

Figures don't count

The Professor of Economics also said he considered economic growth figures that give a number behind the decimal point as completely meaningless.

“Even the figure in front of the decimal point isn't worth much,” he said, adding that most economic forecasts often provide only a range of probability into which growth would fall.

“German economic growth next year is forecast to come in between 0.6 percent and 3 percent, which is an estimate that isn't exactly helpful,” he said.

Speaking in a similar vein is German economist and mutual fund manager Max Otte. In his book “The Crash is Coming” - published in 2006 - he predicted the outbreak of the global financial crisis.

Max otte

Economics must respect human behavior, social interaction, imbalances and political power, says Otte

Since World War II, the dogma of mathematics and a scholastic approach had gained supremacy in economics, he told DW.

“This will only change if economists pay more attention to sociological aspects and adopt a more holistic approach to society,” Otte said.

However, this school of thought, which was known as political economics, was largely ignored, showing that the entire scientific branch was heading down the wrong way.

“Economists still presume that the market will correct everything. But there is not a single market, there are many markets that work differently,” he said and added that modern-day economists had yet to pay respect to this, if they were to re-establish credibility in them.