What is so fundamentally wrong with Economics and how start-ups can fix it
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I first encountered the field of economics in grade 10, in high school. We were a small class of 15 year-old students, naively intrigued by the idea of understanding business models and the mechanisms that seemed to define and rule the world we live in.
I remember well a general feeling of discontent that started to emerge after a few weeks of our economics classes. Some of my classmates were disenchanted, as we were not learning about companies and how to make money. They would complain about the endless graphs and boring mathematical equations.
However, I felt the complete opposite. I had discovered a field that perfectly divided the world into two actors (consumers and producers), rationalized and analyzed their behaviours, and ultimately, predicted their decisions.
I was enthralled by how the models examined abstract and convoluted constructs as decision making and simplified them to make them look like child’s play. I was excited by the possibility of understanding and predicting something as unpredictable as the human mind via incentive models that captured our every day experiences. I was inspired by all the thinkers, from Adam Smith to Amartya Sen, that had questioned, examined and shaped the field. I felt stimulated, engaged and connected.
You might understand my excitement when I decided to enrol as an Economics student in University, aiming to further explore this logical and rational world. I was ready to learn more. I felt like I had finally found my passion and that I was studying something challenging but also intriguing, with real world applications.
However, I was soon to grow discontent.
This feeling did not emerge because my classes presented the material in dry lecture formats. Nor did it result from my teachers’ goals, often not aligned with a passion for knowledge sharing, but rather to fulfill their research careers. I still enjoyed the material and I still liked the models.
Something else was off, something intrinsically embedded in the fundamental grounds on which the field was built.
I believe this begun when, not too far into my degree, I started to realize a common pattern in all of my economics classes. Every single one of them, from my introductory level microeconomic class, to my advanced calculus in economic theory, had one common underlying premise:
“Firms maximize profits”
When I first approached this rather simplistic and straightforward sentence, I did not think much of it. It made sense. Just like everything else in economics makes sense. It makes sense that consumers wish to maximize utility (economists’ term for wishing to acquire higher levels of happiness or satisfaction). It makes sense that markets will reach a state of equilibrium in which their agents will remain indefinitely. It also makes sense that people want to work for firms, earn an income, and that those firms want to earn as much income as possible.
But, wait. All of a sudden, I started to question whether this simple premise created problems at a societal level. I realized it allowed firms to justify defending their nations while selling arms to those that make of war a profitable business. It encouraged behaviours where unlimited extraction of natural resources and pollution became the norm. It introduced moral hazard problems and perpetuated corruption, discrimination and deception, all for the sake of this bottom line.
Could these behaviours arise from such a basic idea? What would happen if we no longer took firm-maximization as the bottom line? The field that always used to so seamlessly click with me, started to crumble. The individual pieces did not seem to quite fit into the big puzzle any more.
Let’s go back for a second.
I said before that consumers maximize utility. Some people might automatically assume that this means acting selfishly, with one’s desires and goals at heart, despite others. Well, it seems that economists understand that this might not always be the case. This is because utility depends on preferences, which depend on individuals. For this reason, an individual whose preference is to help others, will gain utility from doing so, forgoing perhaps, monetary benefits. I was happy to come across this answer as I have long encountered caring, loving friends who go above and beyond to help others.
I also used to be okay with the concept of market equilibrium, but we know after at least a century of government intervention in markets, that the equilibrium reached by free markets might not be optimal, or factor in all costs and externalities to society. Some might argue that is why we need government, as it might be able to address the imperfections that arise from suboptimal resource allocation.
As the above mentioned points show, economics understands adjustments have to be made, and that not all premises might be as simple as initially stated. I believe this arises from the irrationality so intrinsically embedded in human experience, and interaction.
Yet, when it comes to firms, the assumption remains unchanged.
This small simple sentence, reappearing in all of my university classes, did not resonate with the type of firm I wanted to work for nor create.
In my mind, firms represent human organizations acting as a vehicle for the provision of goods or services and for the betterment of life. How then do profits repeatedly represent the bottom line? Where do people come into the equation? Most importantly, what about their contribution to society, the environment, and development?
I was facing a devastating personal conundrum, as I suddenly was struck with two overwhelming realizations:
- The field of study I had invested my time and interest in no longer aligned with my values and beliefs.
- At age 20, I no longer felt compelled to join this type of company, or even the workforce.
Now that economics was no longer the answer, what was?
Luckily, this is something that I was able to share among many of my friends at university. From those conversations I learned that I was surrounded by a lot of young individuals that had experienced the same realization, and were equally looking for answers.
Empowered by this shared understanding, I decided to do some research, and to get to know some more companies. At that time, I was also starting an idea with two friends, which later on took the shape of a social enterprise focused on economic development in Latin America. Because of this, I was growing increasingly interested in entrepreneurship and the start-up ecosystem.
As I started to read articles, come across startups, and talk to entrepreneurs, I slowly recovered the same feeling of excitement as when I first encountered economics. Here were people who were not constricted by the traditional definition of “the firm”, who constantly talked about adding and focusing on value, and who seemed invested in creating something that would improve not only their own lives, but others’ as well.
Perhaps, firm’s profit maximization premise could be re-evaluated.
Perhaps, start-ups could be the answer.
So, why start ups? Start ups emerge in a unique exploratory niche. This is because they must test, retest, iterate, analyze, and improve themselves. In this regard, they combine the perfect elements to reshape and redefine what drives a firm. Most importantly, they might be able to gain invaluable insight into and become aligned with what truly makes a firm successful in the 21st century.
Additionally, if start ups are led by individuals with a desire to improve their communities, be sustainable (by considering profits but not letting these define them) and add value to customers, maybe our perception of firms could change. Maybe, as these start ups grew and became successful, our expectations for firms could evolve.
Perhaps, this success could be determined by moving from a profit-driven aim toward a value-oriented proposition.
I believe this shift would be a positive one because it would afford a new paradigm regarding the role of firms in society. A value-driven firm would theoretically no longer engage in resource and environmental exploitation, deception and corruption, or even discrimination toward employees, customers or other firms. This is because these firms would see these behaviours as subtracting value, since they would be incorporated in their decision-making equation.
So, could this paradigm shift actually take place via startups? Should we even strive towards it? Could it simultaneously redefine economics, while changing the rules of the game towards a more humane, egalitarian, and transparent society?
I believe so.
In a society where we are becoming increasingly connected and attuned with challenging global issues such as climate change, I strongly believe now is the time to ask:
Will we disenchant our future generations by continuing on our traditional, profit-driven incentive models? Or, will we reexamine economics to attune to a world where profits, human values, and our environment are all equally important and become part of the same equation?
