Economics

Nassim Nicholas Taleb has made a delightful career from explaining why mainstream economic thought is broken. He mixes witty epigrams with pages of math-based risk management analysis so impenetrable that (at least in The Black Swan) he tells the non-technical reader to skip over it.

There are more accessible ways to explain why economics is often, as Thomas Carlyle put it in his 1849 essay recommending slavery, “…a dreary, desolate and, indeed, quite abject and distressing one; what we might call, by way of eminence, the dismal science.”

The entire discipline is flawed because all of the theories are built on a series of arbitrary assumptions which may not be valid.

For one example, every economic theory accepts as an axiom that “consumers will act in a rational manner”. As anyone who has ever worked in retail can tell you, consumers frequently act irrationally.

For another example, every economic theory accepts as an axiom the unidirectional relationship between supply, demand and prices. In reality, the demand for Giffen goods increases as the price goes up. As you read that Wiki page, you will notice a distinct air of mystery, and even a hint of condescension, presumably to avoid the ugly truth that they may have made a mistake.

Economics, like most sciences, claims the ability to make predictions based on constructing models and simulations. That no one can predict the future is apodictic. Even sciences with the most sophisticated simulations and the most up-to-date technology (e.g. meteorology) get things wrong all the time. Yet policy-makers (and news anchors) frequently expect economists to predict the future, and economists never seem eager to disabuse the policy-makers of those notions. Inevitably, due to cynical opportunism, or hubris, or a genuine but misguided instinct to be helpful, we are treated to wave after wave of humiliating failures.

For one example, when the banking and insurance industries crashed into the ground in the US, the king of free market ideology, Alan Greenspan, admitted he made a “mistake”. The mistake was obvious to those of us who had been paying attention, but Greenspan was acting in accordance with the prevailing theories of economics.

For another example, read Ismael Hossein-Zadeh’s well-written and impeccably sourced The Recurring Myth of Peak Oil. The abstract is that there is no Peak Oil problem. It’s a house of cards put together on a fundamentally-flawed understanding of economics.

For your consideration: further evidence that economics might just be useless.

Exhibit A: In 1970, Richard Titmuss conducted a famous study into why people donate blood. A group of previous donors were requested to donate blood, and offered a small financial reward for doing so. A control group of previous donors were asked to donate blood without any incentive. 63% of the first group ended up donating, where as 90% of the second group donated.

It has been suggested that the reason for this counter-intuitive conclusion is “pricing undermines people’s sense of community and cohesion because people are deprived of the opportunity to express altruism and no longer face the moral conflict and challenge to answer the question about their obligations to strangers”, but your guess is as good as mine. There is no widely-accepted theory of economics which explains this.

Exhibit B: In 2000, Uri Gneezy and Aldo Rustichini conducted a study in an Israeli kindergarten. Although it sounds like a set-up for a joke, the teachers had a problem with parents arriving late to collect their children. They had to stay there until the parents came, which was inefficient. So they introduced a disincentive: a small fee. Upon the introduction of the fee, the number of parents arriving late increased dramatically.

It has been suggested that the reason for this counter-intuitive conclusion is “that penalties are usually introduced into an incomplete contract, social or private”, and “the deterrence hypothesis loses its predictive strength, since the clause “everything else is left unchanged” might be hard to satisfy.” In other words, they don’t know. There is no widely-accepted theory of economics which explains this.

Exhibit C: There is a wonderful piece of economic torture called the Ultimatum Game. Two people are put into a room. One of them is given ten dollars. He may choose to give any amount to the other person. If the other person accepts the offer, both of them keep their money. If the second person does not accept the offer, no one gets anything. Generally, offers of three dollars or less are overwhelmingly rejected.

All economic theories predict that an offer of one dollar should be made and accepted, but when dealing with “rational consumers”, this very rarely happens. Read the explanations that Wiki offers if you like. It’s entertaining to see experts in (any field, but especially) economics scrabble around in the dirt, desperately searching for some sort of explanation for the madness that is the human brain, and trying to convince us all that their discipline still has some value.

To sum up: While economics may have some value as a forensic science, it can tell us nothing about human behaviour without “borrowing” from the far superior methods and conclusions of psychology or philosophy, and it can tell us nothing at all about the future. Professional economists need to stop making predictions, or at least stop pretending that those predictions have any value.