In response to “Economics has met the enemy, and it is economics”

(The article this post refers to was published in the Globe and Mail, Saturday, Oct. 15, 2011 6:00AM EDT, Last updated Sunday, Oct. 16, 2011 12:13AM EDT)

I was puzzled by the impression this article gives that there is “one” economic theory. Perhaps it is worth to remind the readers that although economic theory dares to predict some events, this predictions are done under very specific sets of assumptions. And, as we keep reminding our students, departures from those assumptions dramatically change those predictions. Stating that "the" (one and only?) economic theory only upholds efficient markets and frowns upon all forms of government interventions, only tells me that these people are very selective in their economic readings and that they missed the lecture on externalities and market failures. The article provides a partial view of the theory of rational expectations, but it fails to mention that this theory only provides a benchmark for how markets function (or rather should function) when, among other things, there is full information, agents are all identical and there all the costs and benefits of a transaction can be accounted for. Most economists, theorists and interested citizens with common sense recognize the theory of rational expectation for what it is, a useful tool. And the job of many theoretical economists has to do with learning what happens when these assumptions are not true.

It is childish and naive to blame "math" for the economic crises. Abstraction is not, it just cannot, be the culprit here. The problem does not lie with rationality or math, but with the way models are interpreted and used in politics and public life. As in all other sciences (natural or social) economics has "good" theory and "bad" theory, the good and the bad having nothing to do with the morality of the results or their mathematical complexity but with the transparency of the logical link between assumptions and propositions. Good theories provides a framework for thinking about a problem, outlining the plausible main forces behind it. It gives direction and provides its own limitations. It may or may not use math, although it will almost always use abstraction - how else can you reduce the complexity of society to a tractable problem? All the other disciplines mentioned in the article (sociology, statistics, psychologists or anthropologists) and a few of the new branches of economics the article mentions use abstraction, and some of them even use math. “Bad” theory, on the other hand, fails to uncover the main issues behind the problem, hides the assumptions leading to the conclusions and present logical failures, regardless of the degree of mathematical sophistication employed (which can be plenty as well).

Blaming economic theory for the recent market collapse is like blaming Einstein for the bombing of Hiroshima, or thinking that we would be better off without any of the physics development that could have led to nuclear bombs. Despite what the article wants to imply, neither natural sciences, nor social sciences have a moral dimension. Knowledge is just knowledge. What we chose to do with that knowledge is up to all of us.

Left and Right together

Sometimes it seems, especially in the US, as if left and right can't find common ground. In a surprising exception to this rule, the Health Impact Fund recently added to its advisory board Ken Arrow, a Nobel Laureate in economics, and a key contributor to our understanding of the operations of the market mechanism, and Noam Chomsky, one of the most cited academics in the world, whose perspective is much more focused on the abuses of those who dominate markets.

Economic growth and development can take the simplest forms

Welcome new graduate students!

Yesterday, Frank Atkins and I made teaching and research assistant assignments for our graduate students. In doing so, I am reminded of the lessons taught by the Simpsons on graduate education.

Canadian Income Inequality on the Rise

A recent report from the Conference Board of Canada has found that income inequality in Canada has increased over the last 20 years (see the video on the page). The general argument is that increased trade in commodities boosted the Canadian economy to the primary benefit of those in the upper quintiles of the income distribution.

While not as skewed as the income distribution in the U.S., Canada's Gini Coefficient is now at 0.32 (realtive to the U.S. at 0.38). As reported by the Wall Street Journal,

On an inflation-adjusted basis, the average Canadian income has climbed 17% to C$59,700 (US$61,788) over a 33-year period to 2009. Yet, the board noted median income — or the level that divides Canadian income earners into two equal parts and is said to be a better indicator on how the majority of households are doing — rose just 5.5% in the same time period.

Yet, inequality is not the be all and end all: while incomes for everyone may rise, inequality can rise if the rate of increase varies across income group. That said (again from the WSJ):

It said the average income level of the poorest group of Canadians — excluding government benefits, after-tax and adjusted for inflation — rose marginally from $12,400 in 1976 to $14,500 in 2009. As a result, the gap between the real average income of the top quintile of Canadian earners and the poorest group, or the lowest quintile, grew from C$92,300 in 1976 to C$117,500 in 2009.

Voting (or lack thereof) in May election.

As recent article by Statscan suggests that 7.5 million people didn't vote in the May federal election.The reasons are summarized by the following graphic:

If you do the math and read between the lines (amalgamating "not interested," "didn't like candidates/issues," and "forgot"), this suggests that almost 40% or 3 million voters didn't vote because they were uninterested.

Some interesting differences across Canada emerge in the Statscan analysis:

• Lack of interest as a reason for not voting was highest in Quebec;
• Lack of interest didn't seem to differ across age groups;
• Lack of interest was lower among voters with university education;
• Among immigrants with Canadian citizenship who didn't vote, only 13% cited lack of interest.

I know that there are all sorts of analysis we'd like to do on this data to really get at the heart of the matter (Any grad. students interested in working on a paper?) but I think the results point to some interesting questions regarding voter behavior.

Addiction, Stress and Poverty

Last term, I taught Economics 349 "The Economics of Social Problems." In that class we discuss a host of topics, including the inter-relation between stress and addictions (and how these relations are potentially magnified among the poor). Today's episode of Democracy Now features Dr. Gabor Mate discussing many of these issues. Dr. Mate is best know for his research and books on the relationship between physical and mental health.

Take Back Your Vacations

I was forwarded this by and old friend of mine who thought that I, as an economist, would appreciate it. With summer and vacation season upon us, I thought it was worth sharing.

Jon Bon Jovi on Technological Change

...well, sort of.

In a recent article, Jon Bon Jovi lashed out at Steve Jobs for ruining the music industry. Basically, the move to a new technology has so changed the process of "record buying" so as to have killed the music industry and changed the culture of music appreciation:

Kids today have missed the whole experience of putting the headphones on, turning it up to 10, holding the jacket, closing their eyes and getting lost in an album.

Next thing you know Mr. Bon Jovi will be complaining about the clothes young people are wearing these days, shaking his fist at clouds, and telling those kids to "Stay off my lawn!"

The First Step Towards Taxing Religion?

I'm a little late to the table on learning about this, but Romania has introduced a new tax, adding "witch" to the existing list of labor codes:

Those charging clients for tarot readings, curses, and blessings must now pay a 16 percent income tax and make contributions to health and pension programs.

As has happened with other previously-considered "cultural groups," as they enter or adapt to market institutions they find themselves subject to conditions that face all market participants.

Witches adapted to a free market quickly. Emerging businesses sought their aide, creating a growing clientele for witchcraft. In 1997, there was an attempt to form a “witches’ union,” in part to counter the claims of dozens of upstart witches that they were descendants of Mama Omida. In 1999, there was even a plan to build a thirty-five room “national center of witchcraft” on the outskirts of Bucharest. However, the witches appear to have become victims of their own success. The idea of taxing witchcraft was first put forward in 2001.

HT: @acrofish

Police versus Education, War versus Hospitals

The 2011 World Development Report has been released. Here's a bit form its web site:

More than 1.5 billion people live in countries affected by violent conflict.
The World Development Report 2011: Conflict, Security, and Development examines the changing nature of violence in the 21st century, and underlines the negative impact of repeated cycles of violence on a country or region’s development prospects. Preventing violence and building peaceful states that respond to the aspirations of their citizens requires strong leadership and concerted national and international efforts. The Report is based on new research, case studies and extensive consultations with leaders and development practitioners throughout the world.

Some are arguing that this report represents a major change in the way the World Bank is advocating aid resources be allocated. Indeed, it appears that the Bank is advocating resources be used in building stable governments, justice and police... rather than emphasizing education and health. From the BBC:

The report says if there is not a major refocusing of aid in this direction, then other targets on poverty, health and education will not be reached.

There is far more spent on alleviating the effects of conflict than preventing it from breaking out, and conflicts tend to be repeated.

The "Heart of Economics"

I'm currently teaching a course on "the economics of social problems." It can be a tricky course because I need to communicate to students that, for example, poverty is about more than low income. Its also about opportunities, happiness or well-being, cognitive adaptations (i.e., beliefs) and more.

With this in mind, I found today's piece in the NY Times by Ed Glaeser interesting. He writes:

Teachers of first-year graduate courses in economic theory, like me, often begin by discussing the assumption that individuals can rank their preferred outcomes. We then propose a measure — a ranking mechanism called a utility function — that follows people’s preferences.

But then we turn to welfare, and that’s where we make our great leap.

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

Economists’ fondness for freedom rarely implies any particular policy program. A fondness for freedom is perfectly compatible with favoring redistribution, which can be seen as increasing one person’s choices at the expense of the choices of another, or with Keynesianism and its emphasis on anticyclical public spending.