The Story of Economics 'Cogs'

Summary

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More or Less: The Story of Economics 'Cogs'

BBC Radio 4 | March 23, 2011
Host: Michael Blasland (with contributions from Phil Flynn, Leo Melamed, Charles Whelan, Alan McRobie, Joe Stiglitz, John Kay, Raghu Rajan, and others)

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Episode Overview

This episode dives into the mechanics—"the cogs"—of modern economics, focusing on markets as complex, self-organizing systems, the debate between market and government roles, the quest for scientific certainty in economics, and the aftermath of market failures. Through expert interviews, site explorations, and real-life stories, the episode interrogates the analogies, models, and real world consequences grounding economic theory.

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Key Discussion Points and Insights

1. On the Trading Floor: Markets as Machines (00:31–04:23)

• Setting: Begins on the Chicago Mercantile Exchange’s trading floor, capturing the intensity and chaos of open outcry trading.
• Phil Flynn (Trader):
  • “You can blindfold a trader and he can listen to the roar of the crowd and tell you whether the market’s going up or going down.” (01:30)
  • Advocates for the wisdom of markets over politicians:
    “The markets know better than the politicians or the people what a price should be worth. You know, if you see a speculator, give him a hug today because he really does an amazing job.” (01:51)
• Leo Melamed (Former Chicago Merc Chair):
  • Childhood story during WWII as a lesson in market value, not government fiat: “That lesson, I mean, resonated with me for the rest of my life, that the market is the only way you can determine true value.” (04:10)

Insight:
The segment illustrates the almost mystical faith many traders and economists place in markets as self-correcting, value-assigning mechanisms with reference to both experience and economic lore.

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2. Markets Versus Central Planning: The Sandwich Shop Analogy (04:23–07:47)

• Charles Whelan (University of Chicago):
  • Contrasts the organic spread of Potbelly sandwich shops with the Soviet Union's central planning: “I think it’s really instructive to contrast that with an old fashioned, centrally planned economy… you’re pushing processed meats out the door to the sandwich shops that people don’t particularly want to eat, which is why the supermarkets and the Soviet Union never seemed to have what people wanted to buy… The market does that all just with price signals.” (05:45–07:19)

Insight:
Markets handle vast, complex allocations through price signals and consumer choices more efficiently than top-down planning, a recurring theme reinforced by real-world comparisons.

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3. The Invisible Order: Bread in Cambridgeshire and The Pencil Analogy (07:47–10:20)

• Investigation at a local bakery in England demonstrates that no one is "in charge" of the bread supply—orders arise organically between business and customer.
• Reference to economist saying, “no one person on earth knows how to make a pencil,” highlighting the dispersal of knowledge and coordination in market economies.

Insight:
This segment illustrates classical economic arguments about decentralized knowledge and spontaneous order, using ordinary goods as vivid examples.

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4. Economics as a Science: The Limits of Laws and Models (10:20–13:23)

• Historians Mary Morgan & Roger Backhouse:
  Draw parallels between macroeconomics and astronomy, emphasizing modeling, observation, and the quest for deterministic laws: “In lots of ways, that’s rather like macroeconomics. We have lots and lots of data and we have mathematical or statistical models…” (11:32)
• Rise of technical (mathematical, model-driven) economics during the 19th and 20th centuries, shaped by physics envy and pursuit of scientific credibility.

Insight:
Economics aspires to scientific rigor, but faces inherent limitations. The application of physical science’s methods is both clarifying and misleading.

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5. The Keynesian Alternative: Modeling the Machine (13:23–16:56)

• Introduction to the Phillips Machine—an actual hydraulic analog computer modeling the Keynesian economy:
  • Alan McRobie (Unofficial Curator):
    “It definitely works as a model of the Keynesian theory of the economy, and it solves the equations of John Maynard Keynes very precisely... But whether the Keynesian view… is correct is a question for an economist.” (14:54)
• Visualizes government spending, taxation, and borrowing as flows of water, illustrating the attraction of economics as an engineering problem.

Insight:
Keynesianism tried to render the economy “manageable” as a machine, but the episode plants doubt about whether economies are ever so predictable or tweaked so precisely.

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6. Market Failures and the Limits of Science (16:56–20:41)

• Joseph Stiglitz (Nobel Economist, Columbia):
  • Blames recent crises and persistent unemployment on market failure, not government: “Clearly, the market did not work well… What I would call scientific economics… show unambiguously that markets are in general not efficient. So from a scientific point of view, there is no debate. You know, one side has won.” (17:15, 17:53)
  • Critiques poor incentive design in financial compensation structures: “Anybody can make money by taking more risk, on average, but with downside consequences if things don’t turn out.” (18:50)
• Narration: Highlights paradox—both market advocates and critics lay claim to scientific authority, but both admit to knowledge limits.

Insight:
The episode critiques both market fundamentalism and technocratic Keynesianism, noting that neither can guarantee stability or scientific certainty.

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7. The Free Market: Spontaneous Order but Shambolic Reality (20:41–21:54)

• John Kay (Economist):
  • “One of the very large and in some ways puzzling questions of economics is why the uncoordinated, to some degree shambolic free market process actually worked better… than the coordinated, centrally planned regimes…” (20:41)
  • Skeptical of models as literal representations of economic reality, but sees value in their illustrative power.

Insight:
Even the best economic models fall short of capturing the complexity and unpredictability of real economies.

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8. Accepting Uncertainty: Room for Ideology (21:54–24:24)

• Raghu Rajan (University of Chicago):
  • On economics’ lack of precision: “It’s really hard to be precise, and I think it’s not particularly wise to pound on the table and say, I’m right and everybody else is wrong.” (22:27)
  • Science vs. social science: “If by science you mean… we drop this ball and this is the rate of acceleration, no, we cannot be as precise as that… However… we can talk about the direction of some of these forces.” (22:47)
  • On why disputes persist: “Because there is that leeway, we have room for ideology, right? Because you can have a progressive economist thumping on the table and saying, we should have more spending, and you can have a conservative saying, we should cut taxes and reduce spending tremendously. And both can coexist without either one being proved to be a charlatan.” (24:01)

Insight:
Economics lacks the certainty of physical sciences, leaving space for ideological battles.

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9. Real-World Consequences: Chicago’s Subprime Fallout (24:24–27:58)

• Mabel Guzman (Chicago Real Estate Agent):
  • Tours a neighborhood devastated by the subprime crisis: “When I was on the Gulf coast and I saw these board ups, I can explain that it was based on wind, rain, water… But when you drive down here board ups, there was no physical force. It’s this very quiet thing that happens one day. All of a sudden the property’s boarded up.” (26:32)
• The human cost is contrasted with the abstract models discussed earlier; unforeseen collective actions can devastate communities.

Insight:
Economic models’ limits are starkly revealed in financial crises, with real people facing consequences invisible to theoretical systems or market mechanisms.

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Notable Quotes & Moments with Timestamps

• Phil Flynn:
  “If you see a speculator, give him a hug today because he really does an amazing job.” (01:51)
• Leo Melamed:
  “That the market is the only way you can determine true value.” (04:10)
• Charles Whelan:
  “The market does that all just with price signals.” (07:19)
• Historians (Mary Morgan & Roger Backhouse):
  “…modern macroeconomics… has been rather like the science of astronomy.” (11:32)
• Alan McRobie:
  “It definitely works as a model of the Keynesian theory of the economy, and it solves the equations of John Maynard Keynes very precisely.” (14:54)
• Joe Stiglitz:
  “…from a scientific point of view, there is no debate. You know, one side has won.” (17:53)
• John Kay:
  “…the uncoordinated, to some degree shambolic free market process actually worked better…” (20:41)
• Raghu Rajan:
  “…we can talk about the direction of some of these forces. Very hard to estimate the magnitudes exactly.” (22:47)
• Mabel Guzman:
  “…when you drive down here board ups. But there was no physical force. It’s this very quiet thing that happens one day…” (26:32)

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Concluding Notes

• The episode weaves together powerful narratives and expert views to illustrate the persistent uncertainties and ideological divides in economics.
• Though markets appear self-organizing and efficient, both theory and recent history show their vulnerability to failure—and that no model can fully contain economic reality.
• The tension between economics as a science and as an art is unresolved; both hubris and humility are in evidence.

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Next Week:
The series promises to explore the roles of psychology, culture, and everyday behavior—the “human cogs”—in challenging and shaping economic theory.

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Transcript

[Narrator]

Thanks for downloading this podcast from the BBC. Though it might not be what you expect, some of the people behind More or Less have been busy making another series, the Story of Economics, presented by Michael Blasland and broadcast in three parts from Wednesday 16th March. Since more or Less is off air, we thought you might like this instead. You can find out more about this [e-mail].

[Michael Blasland]

Last week we left the gods of the Acropolis, the idea of economics as morality, and looked towards the agora, the market. This week we begin on the trading floor of a financial market at the Chicago Mercantile Exchange. What you hear behind me is the open outcry, as it's called, of people buying, selling, haggling. There's a riot of colour voices, the litter of forgotten trades in scraps. On the floor across the walls, there are prices flashing red, green, orange. The pit they call the business end of all this. Think fish market, think flower market, think cattle auction all rolled into one. A ruthless fizzing machine of amazing complexity. From economic Gods, this program turns to the economic cogs of the market.

[Economics Commentator]

In the gallery overlooking the pit, we bump into Phil Flynn, a trader and Fox News pundit. Some people hate markets. Phil loves them, really loves them.

[Phil Flynn]

You can blindfold a trader and he can listen to the roar of the crowd and tell you whether the market's going up or going down.

[Michael Blasland]

What do you know?

[Phil Flynn]

Right now I'm listening to it sounds like it's going up okay, and you can hear the roar. If you're standing there waiting for an economic number, it gets quiet. It's just an amazing feel.

[Michael Blasland]

Does it give you a reverence for the way that markets work?

[Phil Flynn]

It does. The markets know better than the politicians or the people what a price should be worth. You know, if you see a speculator, give him a hug today because he really does an amazing job.

[Economics Commentator]

Hug a speculator? Maybe another day. Open outcry is dying. These days, most of the action is on computer screens, a move led by Leo Melamed.

[Phil Flynn]

He.

[Economics Commentator]

He's a former chairman of the Chicago Merc, almost 80 and a legend in this city of traders. Leo loves the market too, which is just as well as it has a tendency, he says, to get its way.

[Leo Melamed]

Without it, you don't really have the identification of value. Value can be established in the open marketplace. It can't be established because someone thinks this is worth X. No, no, no. The world has to say it's, it's worth X. And then, you know, that's the value. When I was seven Years old. Together with my father and mother, we escaped from the Nazis. We had been captured in Poland. When war broke out, I was seven. And we began a trek across two thirds of the world to Japan, because it was the only way to run during that period of time. My father was a teacher, so everywhere we went, he would sit me down to teach me something. So one day in Lithuania, he held up his hand, he said, what's this? And I looked at it and I said, well, that's a zloty. I knew that was the currency of Poland because I just come from Poland, so I knew the currency unit was a zloty. He said, right, now, what's this? Well, I didn't know what that was. He says, that's a lit. That's the currency unit of Lithuania. Oh. I said. He says, well, what are they worth? Well, I said the same thing. He says, well, let's find out if it's worth the same thing. And he takes me to a bakery. I mean, it's a true story. Takes me to a bakery and asks the baker, how much is a loaf of bread? And the baker says, a lit. So my father says, we'll take it. And he hands him a zlotte. And the baker says, oh, no, no, no, no. Two zlotys, one lit. What a lesson for a kid seven years old, to understand that currency isn't what the government says.

[Michael Blasland]

So there was an official rate which insisted that it was one to one.

[Phil Flynn]

It's the same.

[Leo Melamed]

Yeah, one to one. But the baker knew better.

[Michael Blasland]

The market knew better.

[Leo Melamed]

Well, of course the market knew better, and the baker was part of that market. That lesson, I mean, resonated with me for the rest of my life, that the market is the only way you can determine true value.

[Economics Commentator]

You can't buck the market, as Mrs. Thatcher put it, a force of nature. More than one Chicago economist has said. You notice that about economics, this language of hard rules and science. They talk of market forces, laws, sometimes iron laws, of supply and demand, the price mechanism, equilibrium. It's a mixture of physicist and bloke with his head under the bonnet. Until the 20th century, government was a small player in the economy, at least by today's standards. Then we had depression in the 1930s and war in the 40s, and emerged believing that government, not the market, was the answer. But by the 70s, unemployment and inflation were rising. The UK was up and down like a fiddler's elbow through hyperactive cycles of boom and bust. Faith in government tumbled. Here in Chicago, meanwhile, cheerleaders for a Market revival were winning Nobel prizes, among them Gary Becker and Milton Friedman. When Soviet communism, with its planned economy, imploded in 1989, after decades of supposed miracles, the market was triumphant. Thirty minutes uptown from Chicago's skyscraper financial district, we meet Charles Whelan, who also teaches at the university. We popped into his favourite cafe, which the market is treating well.

[Charles Whelan]

So let's start with where we are. So we're sitting in a sandwich shot potbelly, which I think this is the original one. And now it's been turned out to be quite popular, so it's spread. If you go to Midway Airport, you can eat there. I think it's in five or seven states or something, something like that. And the reason it's been popular is people happen to like the sandwiches. And so when they're walking down the street, this is where they opt in. And there's no need in a market economy to plan where the sandwich shop goes or where you have to eat your lunch. I think it's really instructive to contrast that with an old fashioned, centrally planned economy, the way the Soviet Union would have done it in 1985, which is there would be somebody sitting in Moscow and his job would be sandwich shops. He would say, oh my God, we've got this entire country, it's enormous. Where should the sandwich shop go? And he would, you know, he'd have a staff of planners and they would have maps of every city and they say every city must have two sandwich shops. And then there would be the menu division and they would be in charge of deciding what these sandwich shops ought to sell. And then there'd be all the production. You know, we got to make sure that the turkey actually gets to the sandwich shop in Vladivostok. And then we got the corruption division, which is they're actually selling. I mean, think about the monumental amount of work. And by the way, everything I've described has virtually no consumer feedback. So you're probably, you know, you're pushing processed meats out the door to the sandwich shops that people don't particularly want to eat, which is why the supermarkets and the Soviet Union never seemed to have what people wanted to buy. And if they did, it was underpriced and it would go off the shelves in a second. It's a huge, complete nightmare. Just in terms of the amount of work required to figure out where you're going to put. That's just sandwiches. Someone else in the office, down the office is doing tennis shoes and somebody else is doing shirts and they're all, you know, hundreds and hundreds of planners trying to figure out where all this stuff goes, which is just. And they're going to get it wrong, which is what they did in the most case in the Soviet Union, not because they're incompetent, but because the task that we're asking them to do is nearly impossible. The market does that all just with price signals. If you're selling something people don't want to buy, you either got to lower the price or close your doors and do something else.

[Michael Blasland]

Forgive me while I rhapsodise for a moment about market economies, because you observe these things, these vast, glorious machines, and they allocate and sift and sort and price, and they take commodities and raw materials and they mix them with people, with all their needs and ambitions and expectations and values, and this great titanic mechanism just somehow brings it all together so that I can go into a supermarket and find a very particular loaf of bread that I like on the shelf in front of me, and it can do all this at an infinitely smaller fraction of the cost than I would pay in time and effort and money to do it myself. And, well, here we are in a small village, Cottenham in Cambridgeshire, in a very tiny, tiny cog in that mechanism, and we've come to Barker's Bakery and

[Economics Commentator]

I'm going to ask a very stupid

[Michael Blasland]

question in a moment, because there is another way of doing this. We didn't have to leave it to this beautifully calibrated watch, this magnificent computer, to do it all on its own. We could have tried to organize it ourselves. So we're going to find out why we don't. Hi, can you tell me who's in charge of bread for Cambridgeshire?

[Narrator]

Perhaps you should go speak to Michael

[Mabel Guzman]

at the main bakery.

[Narrator]

All right.

[Michael Blasland]

We'd better go and have a chat with Michael and find out if he is in charge. Thanks.

[Raghu Rajan]

Thank you very much.

[Michael Blasland]

Oh, could I have a gingerbread man? Well, we've just left a very perplexed shop assistant. Rightly perplexed, actually. It was a very stupid question, although not completely stupid, because there were various economies in the past. The Soviet Union is the one that most obviously springs to mind where they really did try to plan the delivery and the organization of all these economic activities. So we've come up to the main bakery to see Michael Todd, who's the commercial director. Michael, are you in charge of bread production for Cambridge? Well, that would be very nice, wouldn't it? But we like to think we are relatively decent sized companies supplying bread into Cambridge. But we're certainly not the only suppliers. We've talked a little bit about other kinds of regimes, like how we organize an economy in the Soviet Union, or how they used to, at least. And one of the questions that kind of dumbfounded people around that time was, how much should you make? It's a very good question. We'll start off in the morning making to an estimate. But with regards to our customers, our customers tend to place their orders for next day delivery. So come sort of half past two, three o', clock, we will know exactly how many loaves of bread we need to make for tomorrow's delivery.

[Economics Commentator]

I asked Michael if he knew how to cultivate yeast. No, he said, a little sheepishly, but why should he? He only runs the place. And I'm serious. An economist friend of mine likes to say that no one person on earth knows how to make a pencil. Her point is how well the machine organises itself. Excuse me for a moment while I take in a quick game of pool at my local American pool hall. The great Scottish Enlightenment philosopher David Hume

[Michael Blasland]

famously used billiard balls to show how

[Economics Commentator]

we learn about causality.

[Michael Blasland]

That is, the way that one thing leads to another, all those angles and forces. And you could tell the entire story of economics as a quest to find deterministic laws about how one thing leads to another, or not. Of all social sciences, economics has been

[Economics Commentator]

perhaps most influenced by natural science as an ideal of laws originating in nature. But science can mean many things. Let's hear from our two historians, Mary

[Michael Blasland]

Morgan and Roger Backhouse.

[Narrator]

What do we think a science is now? I think people's view of a science now is that it's something like physics. It has some really strong natural laws that make things happen, as it were, something like mechanics. And its practical aspect, is it a laboratory science. But there's lots of things that aren't like that. I mean, astronomy, of course, the preeminent science, if you like, of the early modern period is not a laboratory science. It's a science of observation, going out, measuring these things and small mathematical, actually object models, physical models, and then mathematical models about the nature of the behavior of these planets in our solar system. In lots of ways, that's rather like macroeconomics. We have lots and lots of data and we have mathematical or statistical models in which we try and fit the data with our models. So in some sense, modern macroeconomics, or macroeconomics for the last hundred years has been rather like the science of astronomy.

[Phil Flynn]

Economists have for a long time thought of their science as similar to the physical Sciences. Adam Smith, like virtually everyone in the 18th century, was concerned with Sir Isaac Newton and Newtonian physics. So I think economists have been trying to be scientific for quite a long time. I think rather than thinking about whether economists are scientific, it's more useful to think of economics becoming more technical. For example, in the early 19th century, you find David Ricardo, the time of the Napoleonic wars, using numerical examples to make points that now we would think of as abstract theoretical points. Nowadays we would use algebra or geometry or things like that. And then I suppose you have another big change towards the end of the 19th century, and it's from this point that you begin to get economics books that look like mathematics books.

[Economics Commentator]

It's time to take a look at the other side of this argument. Many who dislike the market's forces, laws and mechanisms think that it repeatedly overheats, then blows almighty gasket with wretched human consequences. And when it does go wrong, crunching bank lending, for example, it emphatically does not sort itself out. Often these critics are Keynesians of one sort or another after John Maynard Keynes. But what's ironic about the original Keynesian opposition is that it also became a machine. And we're going to see it about the size of a large wardrobe, it sits proudly in Cambridge University full of pumps, vessels and water to mimic the flow of money around the economy. Invented in 1949 by Bill Phillips, its unofficial curator is Alan McRobie.

[Alan McRobie]

Phillips was an amazing guy. He was an engineer, he was an electrical engineer, and he was studying economics at the lsc, London School of Economics, and he didn't really understand it, and he went to see his tutor as a young student and said, I don't really understand economics, but I understand plumbing. I think the two of the same set of equations, and I can build you a set of plumbing kit that will solve your equations. And to the eternal credit of this supervisor, they said, go on, then, rather than get out of my office, Sonny Jim. And this is what Phillips came up with.

[Economics Commentator]

What do you think, Alan?

[Michael Blasland]

Do you think it. I mean, I know it works, but does it work as a representation of the economy?

[Alan McRobie]

It definitely works as a model of the Keynesian theory of the economy, and it solves the equations of John Maynard Keynes very precisely, within 4% and so forth. But whether the Keynesian view of the economy is the correct one is a question for an economist.

[Michael Blasland]

Let's switch it on. Tell us what you're doing, Alan. A few adjustments going on here.

[Alan McRobie]

I'm just balancing the budget. Very easy.

[Michael Blasland]

Oh, that's too Long David Cameron should give you a job. How did you do it?

[Alan McRobie]

You just balanced the taxation income from the government with the government expenditure at the bottom there. So those two valves have to be the same setting.

[Michael Blasland]

So essentially you're just making sure the same amount of water pours in as pours out.

[Alan McRobie]

Yes, it needn't do. The government can borrow from the bank via this at the back if it wants. There's the bank of England over here, and the government can borrow. So this would be government borrowing over here if it wanted to run a budget deficit.

[Michael Blasland]

So the government borrowing again represented by a flow of water from another tank over on the right hand side by

[Alan McRobie]

a hidden flow of water. It's rather interesting that it's sort of hidden at the back of the machine, but this is the public sector borrowing requirement. It's a little flat here.

[Economics Commentator]

So I thought this is why so many economists are intellectually fascinated by models. Got an economic problem, Open or close a valve, regulate the flow this way or that? The principle is still alive, as some Keynesians argue now in the most urgent debate of the hour, whether the government should spend to stimulate the economy, open that valve. It's more complicated than it looks. But the Phillips machine's case, if a gurgling cupboard can make one, is that the economy must be tweaked in a scientific way, of course, because markets fail to meet one of the fiercest critics of the market. We need to go back to the States.

[Michael Blasland]

We're on the campus of Columbia University in New York, where there's still some snow on the ground. And we're here because there were not many academic economists who before the crisis thought we were going to come seriously unstuck. But we're going to see one of them. Joe Stiglitz Nobel Prize WINNER

[Joe Stiglitz]

There are a whole raft, a whole long list of market failures, the most obvious examples of which are persistence of unemployment and the crash that we've just gone through. Clearly, the market did not work well. My view is that the failure we've been through the crisis is a result of markets not working well. Governments can be criticized, but the main criticism of government is not stopping them from behaving in the bad ways in which they have behaved repeatedly. So it was really the doctrine that markets worked well that led many governments to say we don't have to restrain markets. And now governments are being criticized for not restraining markets and saying it was a problem with the government, but let's, you know, it was totally a failure of markets. What I would call scientific economics Economics that is not based on ideology, that takes into account instances where information is imperfect, which is always where different people know different things, where markets for risk may not exist or be imperfect, show unambiguously that markets are in general not efficient. So from a scientific point of view, there is no debate. You know, one side has won. Hangs down in this.

[Economics Commentator]

Joe took no prisoners in our interview. We can know. We do have good evidence on the big questions, he argues, and what we know for sure is that the other side got the system wrong.

[Joe Stiglitz]

Our business leaders picked up a few interesting words of vocabulary. They said it's important having incentives. And they then designed systems that were called incentive systems and seemed to have some correspondence between something they did and some pay some compensation. And so they could feel good to themselves that they had adopted something that was consistent with what sophisticated people said was a good economic system. But when you looked at it more deeply, they were extraordinarily naive, you might say stupid, because the incentives were not well designed incentives. The incentive structures made no difference whether you increase your profits by taking more risk or whether you made more profits by, at a given level of risk taking, being more efficient. Anybody can make money by taking on more risk, on average, but with downside consequences if things don't turn out.

[Economics Commentator]

I flinch from taking on Joe Stiglitz, who's a giant in the field, I really do. But does anyone else see similarities between him and his opponents? Both reject ideology. Both seek the mantle of science. Both have similar doubts about who can really know what. Your machine can't work, not won't, can't. People don't know enough to make it work properly. No, no, it's your machine and the meddling with it that can't work. You just don't know enough to make it work any better than it does on its own. What if they're both right? What if the machine is just erratic, eccentric in an unknowable way that makes it both more than a machine and impossible to regulate with confidence? The economist John Kay has seen many economic models of how the cogs fit.

[John Kay]

In a sense, one of the very large and in some ways puzzling questions of economics is why the uncoordinated, to some degree shambolic free market process actually worked better and more efficiently than the coordinated, centrally planned regimes you know of, for example, Eastern Europe and the Soviet Union. It's a conclusion that still remains quite significant, surprising, and yet it's empirically true. And these kind of mechanistic models that tell us the ways in which coordination can be achieved spontaneously without people designing it are very illuminating and helping us, I think, to understand that process. The mistake which today, I think, a lot of economists make is believing that these kind of models are actually realistic descriptions of how real economies operate. They plainly are not. The mechanistic approach isn't without value. It's a very real value. But it's a mistake to believe that what happens in real economies is completely determined in these kind of mechanistic ways. It isn't.

[Economics Commentator]

Is it all billiards? We're returning for the Last Word to Chicago, where there's one more economist I'd been keen to talk to. Raghu Rajan foresaw not only the possibility of a financial crash. He nailed incentives in banking as the likely cause. I wanted to know whether economics, through its language and ideals of laws, models and forces, had deceived itself and others with ideas of physical certainty and precision, which, in the end, were its downfall.

[Raghu Rajan]

It's really hard to be precise, and I think it's not particularly wise to pound on the table and say, I'm right and everybody else is wrong.

[Michael Blasland]

If someone should come to, you say, raghu, you study a science. This is a social science. But you don't sound like a scientist to me.

[Raghu Rajan]

If by science you mean something where we say we drop this ball and this is the rate of acceleration, no, we cannot be as precise as that. However, if you think of this as a complex system with lots of things acting on it, you know, there is a hope that someday we could become more precise as we map out the different forces that are working on this and understand there's a certain amount of randomness in the system, but you can sort of make out what the big forces are. We can talk about the direction of some of these forces. Very hard to estimate the magnitudes exactly. And so sometimes we don't know if there are opposing forces, what the net effect might be. But in some cases, it's pretty clear what the net effect will be, and we can make statements of that kind.

[Michael Blasland]

You're placing the disagreements really on matters of empirical degree. You're not placing them in terms of ideological position or fundamental beliefs in the superiority of markets, say, over governments or whatever. You don't have to say those kind of things still to find an enormous amount of leeway in what economics should tell us to do.

[Raghu Rajan]

I think that because there is that leeway, we have room for ideology, right? Because you can have a progressive economist thumping on the table and saying, we should have more spending, and you can have a conservative saying, we should cut taxes and reduce spending tremendously. And both can coexist without either one being proved to be a charlatan.

[Economics Commentator]

Given the evidence, I admired Raghu's reasonableness. Economics for him is a long and patient game of small gains. Every problem that emerged in the crash was being actively discussed beforehand in some corner of economics, he says. But he readily concedes that we haven't yet cracked growth. We still evidently haven't cracked the business cycle. And you have to ask why? Despite decades of mechanics, these biggest of economic basics elude us. One answer is that it's to do with something moody, maybe irrational. The human factor that makes the economy unstable. In recent years, economics has looked increasingly to experimental studies of behaviour and. And to psychology. That's where we turn next week. One last trip in Chicago before we go with the real estate agent Mabel Guzman to see the human cause and effect in the global system. We're heading to the city's southwest side where a property that might have fetched $175,000 a few years ago is today worth 75,000. 60% of its value wiped out. This is subprime country.

[Michael Blasland]

Where are we now? What are we looking at?

[Mabel Guzman]

We're in Auburn Gresham and right now we're going down Peoria Street. We turned the corner and then we saw these three boardubs that are here on the left. Three foreclosures, one right after the other. One, two, three.

[Michael Blasland]

Okay, so we've got three. Pretty substantial family. Yeah, they are.

[Mabel Guzman]

These are what are considered two flats. Meaning that they're stacked. So you have one flat and then another flat on top of the other. And then you also have lower level. But as you can see, these three have been foreclosed and boarded up.

[Michael Blasland]

What strikes me is this is not a poor neighborhood.

[Mabel Guzman]

Actually this is what is considered it's no, when you look at it, it's very nice, very housing, rich, two flats. A lot of long term owners that really care. They're very passionate about their community.

[Michael Blasland]

You've been down on the Gulf Coast.

[Narrator]

Yes.

[Michael Blasland]

And you've seen physical damage there. Yes, but how do you compare these two? What strikes you about the contrast between these two kinds of property damage?

[Mabel Guzman]

You know, that's interesting because it came to me while I was preparing for this interview. I was driving down, I said, you know what, when I was on the Gulf coast and I saw these board ups, I can explain that it was based on wind, rain, water. But also people can prepare for that kind of force. They know it's coming Insurance companies can also say okay, here's what you we're going to give you money so you can go ahead and repair it. But when you drive down here board ups. But there was no physical force. It's this very quiet thing that happens one day. All of a sudden the property's boarded up. The other thing is that when you look down the street what you're not really sure of which one's next.

[Michael Blasland]

We've got houses boarded up. They stand here like broken teeth. A sense of a community fraying at the edges and behind all these doors. People who've got into these situations through goodness knows what kind of human mess and muddle. Optimism over ambition. Maybe just the belief that they have to behave as everybody else behaves in buying a house. The herd like pressures and that takes us into our next programme. The question that whether economics is fundamentally undermined by human and cultural and institutional pressures and everyday behaviour.

[Narrator]

The story of economics was presented by Michael Blasland and produced by Richard Knight. More or less is back on air from the 1st of April.