Perhaps that is why I increasingly found economic history, which is scarcely taught at our universities, and then inadequately, to be a more useful guide to economic policy decisions than economic theory, which is taught to excess. Meanwhile, the problem has become worse with the emergence of modern finance theory, which — although not responsible for the disastrous folly of so many of the world's bankers in recent years — undoubtedly encouraged them to indulge in it. By "modern finance theory" I refer to the combination of the efficient market hypothesis and the rational expectations hypothesis, which enabled mathematically inclined economists to provide the banks with computer models based on mathematical equations which effectively purported to take the uncertainty out of risk assessment.

It is true that markets are less inefficient than any other form of economic organisation, and that expectations are on the whole rational most of the time. But to derive the mathematical equations and construct the computer models it is necessary to assume total efficiency and total rationality, which is absurd. Economics, after all, is about human behaviour. The notion that you can adequately capture human nature in a series of mathematical equations is inherently ludicrous. Yet that is the premise of modern finance theory, on which bankers chose to rely, to their — and even more, our — cost. 

Mathematical economists contend that in any discussion of a system as complicated as the economy being exact in one's arguments is essential, and that mathematics is a language that can capture this precision. Indeed — and that's just the problem. Endemic uncertainty (whether Knightian or any other variety) makes the precision that exists in the physical sciences unattainable, and makes the illusion that it is attainable unwise and dangerous. Underlying the mathematical economists' position seems to be the assumption that there is no rational space between the certain and the random (or irrational). Not so. Not only is there such a space, but it is where public policy, whether foreign policy or economic policy, properly lies, and where history has to be our principal guide. 

There is also the predictability test. That is how we decide between theories in the physical sciences. But human behaviour — whether in the economic or the non-economic sphere — although not wholly unpredictable, is not sufficiently predictable to make mathematical equations (although interesting) of any practical use. There is an understandable illusion that because economic outcomes, unlike (say) foreign policy outcomes, can be quantified, mathematical equations can be applied to the former area even though they are clearly inapplicable to the latter. But it remains an illusion, since the fact that economic outcomes can be quantified in no way mitigates the uncertainty that attaches to all areas of human behaviour, whatever they may be. Modern finance theory, and the mathematisation of economics of which it is a part, are both absurd and — as we have seen — highly dangerous. It may be helpful, from time to time, for economists to use mathematical models to assist in clarity of thought. The danger arises when they confuse their models with the real world. It is notable that the essence of Smith's approach to political economy in the Wealth of Nations is not scientific, let alone mathematical, but historical — informed, of course, by a profound and clear-sighted understanding of human nature.