Saturday, September 12, 2009

Economics in evolution

The salutary effect of the economic debacle of 2008 is that it is forcing economic thinkers to review the conventional wisdom of the past half century.

The European economic thinkers have always approached economics from a philosophical and values-based perspective. You could call it pure economics in the academic sense.

On the other hand, American economic thinkers, particularly those from the Chicago School, tended to be more into applied economics and, tended to use intensive mathematical modelling. Econometrics owes its development very much from this approach.

Another way to look at it is that the values-based approach is classified as normative economics while the applications-based approach is positive economics.

If you are still awake after reading the above, we may soldier on...

Krugman's clue
Paul Krugman's latest blog post, Mathematics and Economics, point towards a growing belief among contemporary economic thinkers that in the wake of the 2008 economic debacle, there is a need to re-inject an understanding of human behaviour into the study of economics beyond numbers. It will be interesting to see how this process will evolve. Instead of recycling the tagline of "normative economics", people are calling this renewed approach to economics, behaviourial economics.

Death of mathematics in economics?
It is impossible to remove mathematics from economics since postulations need to be proven and, you cannot prove or disprove anything without mathematical formulation and statistical data. So, anyone (particularly students) who think that they can throw out their statistics and probability textbooks should refrain from doing so. Economic modelling is here to stay.

Rather, thinkers like Krugman are critiquing the hegemony of Chicago School-types that formulated, developed and encouraged the quantitative approach to economics in the strong belief that human economics and business behaviour - particularly how we look at and, deal with risk - can be reduced into numbers. I believe that in a marketing context, we can include Stephen Baker's The Numerati into this category albeit in a loose association.

Thinkers like Eugeme Fama pushed the thinking that dominated U.S. regulatory and capital market practises that relied heavily on assumptions about availability of information and its effect on fair price and valuation. This was tagged the Efficient Capital Market Hypothesis or Efficient Market Hypothesis. In many ways, it took the Price Theory to its apogee.

In fairness to Fama, he did call it a "hypothesis" and, not a "thesis" or "axiom".

The X-factor in human economic behaviour
At the risk of widespread opprobrium from the wider community of economic thinkers, I make the observation that the 2 things that cannot be quantified are GREED and STUPIDITY. That is probably why behaviourial economics is necessary.

1 comment:

walla said...

Maybe Adam Smith's "Invisible Hand" is really invisible after all. By sleights-of-hand, all the money disappeared into thin air.