Adam Smith is often miscast as the originator of laissez-faire economics. In reality, his work viewed markets as embedded in human-created institutions like law and power structures, a perspective closer to institutionalism than modern neoclassical theory. The phrase "invisible hand" appears only once in his 800-page book.
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Voltaire believed outcomes are shaped by flawed, human-built institutions, not perfect systems. This philosophy directly challenges the Efficient Market Hypothesis (EMH), which assumes a rational, self-correcting market, suggesting instead that markets are shaped by human and institutional biases.
Economic theory is built on the flawed premise of a rational, economically-motivated individual. Financial historian Russell Napier argues this ignores psychology, sociology, and politics, making financial history a better guide for investors. The theory's mathematical edifice crumbles without this core assumption.
Post-WWII, economists pursued mathematical rigor by modeling human behavior as perfectly rational (i.e., 'maximizing'). This was a convenient simplification for building models, not an accurate depiction of how people actually make decisions, which are often messy and imperfect.
The original study of economics was "political economy," which understood the economy as inseparable from politics, law, and history. The late 19th-century rise of neoclassical thought deliberately separated these fields, treating the economy as a natural, pre-political system, akin to a law of physics like gravity.
The idea that government should "stay out of" markets is a flawed model. The government is an inherent economic actor, and choosing deregulation or non-intervention is an active policy choice, not a neutral stance. This view acknowledges politics and government are inseparable from market outcomes.
The debate between liberals and conservatives over state intervention is based on a flawed premise. Both sides accept the idea of a pre-political market that sometimes "fails." The reality is that the market is always a product of political and legal decisions. The real question isn't *whether* to intervene, but who benefits from the current structure.
The prevalent Milton Friedman-style, shareholder-only capitalism has only been the dominant model since about 1970. This neoliberal approach is just one phase in capitalism's history, not its fundamental, unchanging definition. This historical context opens the door for a new consensus to form.
Concepts like "market failure" (e.g., pollution) are framed as exceptions to a well-functioning system. An alternative view is that these are not failures but the intended, logical outcomes of the existing legal framework. Pollution isn't a failure, but a result of property rights that allow companies to externalize waste costs.
For a period, a perverse norm developed in economics where the 'better' academic model was one whose theoretical agents were smarter and more rational. This created a competition to move further away from actual human behavior, valuing mathematical elegance and theoretical intelligence over practical, real-world applicability.
A core methodological flaw in neoclassical economics is its deductive approach: it builds models based on axioms (e.g., perfect rationality) that don't reflect reality. In contrast, institutional economics is inductive, constructing theory from evidence-based observation. This explains why neoclassical models failed to predict the 2008 crisis and why their proponents refused to change them afterward.