Saturday, December 25, 2010

On Economics

As my economics degree draws to a close (I have one semester left, mostly finance subjects) I have come to the weary conclusion that economics as it stands is little better, if not worse than theology.

The quotation that has shattered my thinking on economics is this:

The curious task of economics is to demonstrate to men, how little they really know about what they imagine they can design. ~ Friedrich Hayek, The Fatal Conceit.

When I embarked on this second degree, Bryce asked me why the fuck I was doing it when I should be holed up in a room somewhere drawing. A very valid question. Bryce knows I have a passion for drawing, but do I have a passion for economics? Finance?

The answer is yes, but not of the same variety. This quote by Keynes is a well worn one but worth repeating:

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 influence, are usually the slaves of some defunct economist. ~ John Maynard Keynes, The General Theory of Employment Interest and Money.

The sentiments expressed are exactly why I'm passionate about economics and it's current and continuing malpractice. But while Keynes' quote blew my mind sometime back in year 11 when I first discovered this incisive and observative thinker, Hayek is new to me and the effect on my thinking probably more profound.

He makes drawing the line between economics as religion vs science easy. It reminds me of a book I picked up in a Dusseldorf bookstore called 'irreligious' in the Dawkin's fueld athiest boom of several years ago.

There I came across a particular stunning explanation/argument against 'Intelligent Design' it pointed out that anyobody (capable of picking up that book in a bookstore) could in all likelihood walk down the street and into a shoestore and find a shoe that fits their feet, that they can purchase and walk out of the store with. Same goes for Bras, meals and any other of the complex goods and services readily available to anybody with money in our global economics system.

Does this mean some omniscient being had prior knowledge of my shoe size and material demands and thus 'designed' by some super intelligence? No, the incredibly complex system that produces goods 'for us' is largely blind to our existence. Modern retail has EVOLVED through trial and error, the effecient business practices win out over ineffeciencies and suplant them totally. They are operating on an accellerated evolution to biology because successful business practices can be imitated (loyalty programs, Just-In-Time manufacturing etc.)

The blinding flash of obviousness that Hayek articulates so well, is that economies just like the extreme diversity of life on planet earth is not designed. If you took away the economists, there would still be an economy.

To stick with the analogy for now, it is my belief that morality is something evolved. Many philosophers have struggled over centuries (milennia) to explain our moral system, and yet the field of biology (particularly condensed into 'The Selfish Gene' by Richard Dawkins) provides a far simpler and elegant and satisfying explanation of human moral behaviour. Without exploding the details everyone struggles to explain why consequentialist moral codes only work some of the time/in some situations (Utilitarianism, Machiavellianism) and other times it seems right to be Absolutist (Kant's Deontological Ethics - eg. even if it causes more hurt, you should tell the truth).

Biology says that different genes dictate different behaviours, and the ones that tend to survive certain situations. The implications of this is that there may be no 'right thing to do' or 'right way to live' but infact only a bunch of different right things to do, in different situations.

It is I feel the conceit of most religions to have very specific ways to do the right thing in all circumstances and in the act of subscribing to a particular belief system you can actually circumvent your intuitive moral judgement.

So too it is the Fatal conceit to think we can somehow design a perfect economic system. Much like advertising and it's regulators, the jungle of the market produces behaviours that I feel will always outpace regulation.

Particularly in financial markets the 'sophistication' of financial products (like Collaterised Debt Obligations) is evolving faster than the regulations that govern them.

What then is the role of economics?

Not whatever it currently is. I feel regulation should be on the general rather than the specific but I wouldn't go as far as Hayek to poo-poo say Stimulus in all situations etc.

Robert Schiller, a fan of Keynes points out one problem with free markets and probably the best case for regulation and government intervention in the markets:

'The market is incredibly effecient at producing goods wanted by consumers. The problem being that if the market demands snake oil, it will very efficiently produce snake oil.'

Yes that argument employed by totalitarians everywhere 'people need to be protected from themselves'

Economics as practiced is incredibly complex and suffers ironically from a lack of 'Japaneseness' (If you don't know why this is ironic, look at Japan's economic performance since 1990). That is as a science it lacks the discipline of quality control. Or as Toyota and Honda practice it: Total Quality Management.

Economics is a soft science. Throw out the mathematic modelling and aggregates. We are modelling human behaviour, subject to emotion AND rationality. Take for example 'profit maximising behaviour' one of the central assumptions of (Neo) Classical economists. They say that profits are maximised when Marginal Cost is equal to Marginal Revenue (a further increase in production will not yeild a subsequent increase in revenue). In practice most (if not every) firm cannot know at any point in time that is useful what their marginal cost and marginal revenue is. Most do not price based on economic modelling either, deriving demand curves etc. They use a 'cost-plus-mark-up' approach.

Much of economic modelling that I have learned is of no use whatsoever in understanding how any given business does (or even should) operate.

But observations and tests of human behaviour even in a soft science can be derived from controlled and replicable experiments. Not backfitting mathematics to historical data.

I would dedicate economics as attempting to overcome shortsighted behaviour. Keynes pointed out in the long run we are all dead. I believe the role of economics, beyond Hayek's demonstration of how little we understand is to make that long run as long run as possible.

Economics currently assumes that personal material enrichment makes you happy even though other sciences far more respectable than economics have proven time and again it doesn't. It also doesn't look forward, the GDP maximising model is expressely short term. We FIGHT it to make any provision for the future right now.

Economics needs to be the exact opposite of this. Not to impoverish people but to make sure our material wealth/abundance/opportunity is the maximum in the future. That is it needs to intervene where we cannot see past the short term.

I look at economists of little to no influence in current thinking like Henry George, who illustrates a good example of long term economic regulation - that is using resources as your tax base rather than productive income/wages. This makes it hard to monopolize a resource without productively using it.

It would have made Rockefeller's wealth impossible, it prevents bubbles (or punishes the foolhardy speculators for engaging in speculation) and basically protects people from being suckered into cycles of illusory reward and catastrophic ruin.

But whatever they are teaching in school, has one and one use only - to be informed of the disinformation current economists consider themselves informed by. To give Mark Twain the final word:

'Never let your schooling interfere with your education.'

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