Monetary Conditions

The dismal science

Wednesday September 06, 2017 Dr Ganesh Nana

The term is meant to be disparaging, but I find it incredulous that many economists still see their discipline as a science – let alone a dismal one.

 

The collation of data, the weighing of evidence, the experimentation using models to test alternative hypotheses, and the search for conclusions driven from such interrogations are, sadly, absent from many economists skillset.

 

Rather, economics seems at times a form of cult worship, than a discipline on the quest for improved understandings of the world in which we live.

 

And what do we worship?  Primarily, the market mechanism.  This is placed on a pedestal – and woe betide any who questions its primacy.  The market mechanism is the economist’s construct – where producers bring their wares, consumers bring their dreams, exchange and transactions are negotiated and then completed, wares are consumed and dreams are realised.

 

graph 3

More sophisticated economists assess that there are indeed a myriad of markets and, crucially, they are related to each other.  And, so, to the sophistication.  We assert (hypothesise) that the numerous relationships between the producers, the consumers, (and their respective wares and dreams) across the myriad of markets can be represented by equations.

 

The high priestesses and priests

 

Enter the high priestesses and priests of the cult – the mathematical economists.  The equations, together forming our models of market behaviour, are beautiful pieces of abstract art.  And so they should be worshipped.  But their limitations should also be recognised.

 

During my training (and I openly confess my love of numbers, equations, and maths – and you never forget your first love), I was warned that equations and models were a useful component of an economist’s toolkit.  But, I was warned, they were only useful if after using them you could throw them away and still explain your findings or analysis, and (crucially) justify your recommendations.   If you couldn’t, then the equations and models were getting in the way of the economics.

 

Sadly, though, equations and models (and the related mathematics) have become entrenched at the centre of the economics discipline.  I say sadly because, more often than not, the focus on the beautiful equations overlooks the many assumptions we need to make to construct the equations and associated models.

 

At this stage, the trainee economist is told that the assumptions are only there to simplify the analysis, and they will be dropped later once we have the framework constructed.  Sadly, this proviso gets shunted aside as we bask in the glow of our beautiful constructs.

 

Assumptions

 

And what of the assumptions?  I believe there are two critical ones.

  • Individuals are rational in their decision making.
  • Individuals act to further their own self-interest.

Rationality in decision making means assessing all the information available to us and then deciding a route that would lead us to a better outcome.   Further, the outcome we seek is one that gives us maximum utility (or satisfaction), irrespective of impacts on others.

 

There are several issues with these assumptions that any and all self-respecting (and well-trained) economist should draw to your attention.

  • the focus on individuals.  Most decisions are not made by individuals acting on their own.  Decisions, more often than not, are made by groups of individuals – each with likely individual dreams that may or may not concur with others in the group; for example, company boards and management, iwi, unions, community groups, government, whānau, families.
  • the desired outcome.  The concept that our (as individuals) decision making is targeted at a desired outcome that can effectively be summarised into “more of X is better than less of X” is simplistic at best, if not offensive to many.
  • the use of information.  The assumption that requisite information is not only available, but is readily accessed during the process of decision making, is similarly simplistic.  Information is costly to collate, complex to analyse, and available in a disparate rather than even manner.  Further, all market players are active in disseminating but also suppressing information such that there are critical asymmetries (i.e. the seller is likely to know more about their wares than the potential purchaser).
  • the self-interest angle.  It doesn’t require a behavioural analyst to observe that human beings are, in general, social animals.  What others think of us and our actions are important to most of us.  Similarly, the consequences of our actions on others (especially those close to us) are also important to most of us.  The concept that we are all self-interested animals is a simplicity for most. Indeed, many consider it to be more akin to a parody.

But, as noted above, none of these are intractable as long as we are able to throw away these assumptions at the appropriate time, but remain able to evidence our findings accordingly.  Sadly, the assumptions remain.  The rational decision-making utility maximising individual remains the fundamental cornerstone of economic thought.

 

And, so out the window, go claims to science – dismal or otherwise.

 

The policy impact

 

Does this matter? Or, is this just an academic exercise destined to wallow in its ivory tower?  Well, as a famous economist[1] once implied, many policy (aka political) decisions are founded upon the ideas of economists.

 

“... the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

 

For example, some suggest that poor people are poor because they make wrong choices.  Take, for example, the choice between healthy foods and takeaways.  Economic theory will tell you this is a choice to be made by individuals armed with the requisite information.   So, when poor people make unhealthy choices that’s their fault, they should live with the consequences.  Hence, the argument for intervention in this market is batted away.  Further, if there are health consequences, then that is – again – up to individuals to foresee and purchase appropriate insurance.

 

The missing piece in this puzzle is that individuals are also subject to considerable constraints that act to restrict the options they can choose from.  Interestingly, (for an academic like me this is interesting!) standard economic theory does introduce an important constraint – called the Income Constraint.  But then this introduction is not developed further.  Thereafter is becomes lost in the fog, as the model building progresses and we abstract away constraints and (implicitly) assume all choices are available to all individuals.

 

In a nutshell, it’s not that poor people automatically prefer takeaways over healthy food, it’s just that, for many, the healthy food option lies well “beyond their Income Constraint”.  In other words, that choice is unaffordable and so not available.   And, as for medical insurance, well the United States provides clear evidence of this being well beyond the Income Constraint of many.

 

Noticeably, the Income Constraint may not be as overwhelming for many if the market mechanism was more successful in delivering wages that were sufficiently high to enable a wider range of choices to lie within one’s Income Constraint.  But that’s another example of our market mechanism failing.

 

Objective

 

So, the shortcomings of our concept of a rational decision-making utility maximising individual needs should be recognised.  We could start by rephrasing to individuals decide amongst the options open to them that have been constrained by income, gender, ethnicity, history.  And – of course – subject to constraints caused by the market constructs that others are manipulating (some more successfully than others) towards others’ ends.

 

If so, economists’ approach to problems will be able to move to more comprehensive and (dare I say) relevant analysis.

 

 

 

[1] J M Keynes, The General Theory of Employment, Interest and Money, Chapter 24 Part V, MacMillan, 1936.

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