Tags: Soros | economic | theory | rethought

Soros: Economic Theory Must Be 'Rethought from the Ground Up'

By Dan Weil   |   Thursday, 27 Jun 2013 07:42 PM

Current economic theory is out of date, off base and in need of a total revamp, according to hedge fund legend George Soros, chairman of Soros Fund Management.

"Economic theory has to be rethought from the ground up, because the prevailing paradigm of the efficient-market hypothesis, rational-choice theory, has actually run into bankruptcy very similar to the bankruptcy of the global financial system after Lehman Brothers," he says in a video that appears on the Institute for New Economic Thinking's (INET's) website.

Watch the video. Article continues below.

The efficient-market hypothesis stipulates that financial market prices reflect all that is currently known about the assets in them. Rational-choice theory assumes that individuals balance costs against benefits to determine behavior that maximizes their personal advantage.

Editor’s Note: Put the World’s Top Financial Minds to Work for You

INET is a think tank that began in October 2009, originally funded by Soros and then by others, including former Federal Reserve Chairman Paul Volcker.

"The first phase of INET was to show the bankruptcy of the existing [system], and that is . . . now pretty well done," Soros says.

So what comes next? New economic theories need to be developed, he says. That is "primarily directed at the economic departments of universities, but it has to also address the burning policy issues."

Economic theory needs a total re-do "because economics has been trying to come up with universally valid laws similar to Newtonian physics, and that is an impossibility," Soros says. "So you need a new approach with different methods and also different criteria of what’s acceptable."

Economist Edward Lotterman writes a simple critique of rational-choice theory in an opinion piece on Twincities.com, the website of the St. Paul, Minnesota, Pioneer Press.

He cites financial markets' violent reactions to Federal Reserve Chairman Ben Bernanke's comments last Wednesday that the Fed may taper its quantitative easing later this year.

"If people really are highly rational in their decision making and, as a group, have the best possible understanding of current events and of the future, why such extreme reactions?" Lotterman writes.

Editor’s Note: Put the World’s Top Financial Minds to Work for You

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