A recent trip to Berlinbrought back memories of an earlier visit in the summer of 1967, when I was apoor student who marveled at the Wall thatwould divide and devastate an entire society for another two decades. Berlin today is vibrantand rejuvenated, rebuilt by the Germanpeoples' hard work and sacrifice to unify the country, and an apt setting forthe conference of the Institute for New Economic Thinking (INET), which I wasthere to attend.

The conference’s theme was “Paradigm Lost,” with more than 300 economists,political scientists, systems analysts, and ecologists gathering to rethinkeconomic and political theory for the challenges and uncertainty posed bygrowing inequality, rising unemployment, global financialdisarray, and climate change. Almosteveryone agreed that the old paradigm of neoclassical economics was broken,but there was no agreement on what can replace it.

Nobel laureate Amartya Senattributed the European crisis to four failures –political, economic, social, and intellectual. The global financialcrisis, which began in 2007 as a crisis of US subprime lending and hasbroadened into a European sovereign-debt (and banking) crisis, has raised questionsthat we cannot answer, owing to over-specializationand fragmentation of knowledge. And yet there is no denying that theworld has become too intricate for any simple,overarching theory to explain complexeconomic, technological, demographic, and environmental shifts.

In particular, the rise of emerging markets has challenged traditionalWestern deductive and inductive logic. Deductive inference enables us to predict effects if weknow the principles (the rule) and the cause. Byinductive reasoning, if we know the cause and effects, we can infer theprinciples.

Eastern thinking, by contrast, has been abductive,moving from pragmatism to guessing the next steps.Abductive inference is pragmatic, looking only at outcomes, guessing at therule, and identifying the cause.

Like history, social-scientific theory is written by the victors andshaped by the context and challenges of its time. Free-market thinking evolvedfrom Anglo-Saxon theorists (many from Scotland), who migrated andcolonized territories, allowing fortunate individuals to assume that there wereno limits to consumption. Europeancontinental thinking, responding to urbanization and the need for social order,emphasized institutional analysis of politicaleconomy.

Thus, the emergence of neoclassical economics in the nineteenth centurywas very much influenced by Newtonian and Cartesian physics, moving fromqualitative analysis to quantifying human behavior by assuming rationalbehavior and excluding uncertainty. This “predetermined equilibrium” thinking –reflected in the view that markets always self-correct – led to policy paralysis until the Great Depression, whenJohn Maynard Keynes’s argument for government intervention to addressunemployment and output gaps gained traction.

By the 1970’s, theneoclassical general-equilibrium school captured Keynesian economics throughreal-sector models that assumed that “finance is aveil,” thereby becoming blind to financial markets’ destabilizing effects.Economists like Hyman Minsky, who tried to correct this, were largely ignoredas Milton Friedman and others led the profession’s push for free markets andminimal government intervention.

But then technology, demographics, and globalization brought dramatic newchallenges that the neoclassical approach could not foresee. Even as theworld’s advanced countries over-consumed through leveraging from derivativefinance, four billion of the world’s seven billion people began moving tomiddle-income status, making huge demands on global resources and raising theissue of ecological sustainability.

New thinking is required to manage these massive and systemic changes, aswell as the integration of giants like Chinaand Indiainto the modern world. A change of mindset is needed not just in the West, butalso in the East. In 1987, the historian Ray Huang explained it for China:

“As theworld enters the modern era, most countries under internal and externalpressure need to reconstruct themselves by substituting the mode ofgovernance rooted in agrarian experience with a new set of rules based oncommerce.…This is easier said than done. The renewal process couldaffect the top and bottom layers, and inevitably it is necessary to recondition the institutional links between them.Comprehensive destruction is often the order; and it may take decades to bringthe work to completion.”

Using this macro-historical framework, we can seeJapanese deflation, European debt, and even the Arab Spring as phases ofsystemic changes within complex structures that are interacting with oneanother in a new, multipolar global system. We are witnessing simultaneous globalconvergence (the narrowing of income, wealth, and knowledge gaps betweencountries) and local divergence (wideningincome, wealth, and knowledge gaps within countries).

Adaptive systems struggle with order and creativity asthey evolve. As the philosopher BertrandRussell presciently put it: “Security and justice require centralizedgovernmental control, which must extend to the creation of a world governmentif it is to be effective. Progress, on the contrary, requires the utmost scopefor personal initiative that is compatible with social order.”

A new wave of what the economist Joseph Schumpeter famously called“creative destruction” is under way: even as central banks struggle to maintainstability by flooding markets with liquidity, credit to business and householdsis shrinking. We live in an age of simultaneousfear of inflation and deflation; of unprecedented prosperity amid growinginequality; and of technological advancement and resource depletion.

Meanwhile, existing political systems promise good jobs, sound governance,a sustainable environment, and social harmony without sacrifice – a paradise ofself-interested free riders that can be sustained only by sacrificing thenatural environment and the welfare of future generations.

We cannot postpone the pain of adjustment forever byprinting money. Sustainability can be achieved only when the haves becomewilling to sacrifice for the have-nots.

TheWashington Consensus of free-market reforms for developing countries ended morethan two decades ago. The INET conference in Berlin showed the need for a new one – aconsensus that supports sacrifice in the interest of unity. Europecould use it.