Sunday, September 22, 2013

Thing I wish economists never said

One thing I find surprising about economics is the misuse of models as tools for reasoning.

Think about the basic micro-models. What do they say? They say all markets are in equilibrium. Okay, if that’s the approach you want to take. So how did they get there? Tatonnement? A Walrasian auction. We get there via a central planner who facilitates the equilibrium price before trade is allowed to take place! 

This lack of substance in the fundamental model of markets should beg the question of why markets are preferred over alternative forms of planning? You actually need some other theory to support the assertion that markets are the best resource allocation tools - but such a theory does not exist. 

One problem you face trying to get economists to think deeply about the real life applications of their beloved models is that you have to pretend to take these nonsense models seriously. Don’t be surprised if you get arguments to the effect that real life commercial behaviours must be wrong because the model is right. 

With that short rant over, I want to share a list of phrases and terms that I wish economists never said. These terms illustrate that vacuous nature of economic reasoning, as as you will see, they test the patience of any thoughtful observer. 

Probably top of the list of things you say when you have no idea what is happening in a market - “we need to look at the fundamentals”. Okay, WTF are they? Just your pet theory? You actually need a deep understanding of the institutional history, legal and regulatory structures of markets, and a decent technical understanding to even know what the fundamentals might be. Plucking an uninformed notion of supply and demand out of thin air is not understanding fundamentals.

Second best
Most people who use this term actually don’t understand its meaning. In the equilibrium model of markets if one market is not in equilibrium, then no other market can be in equilibrium - it’s all or none. The idea of second best is that if in reality there are some markets that aren’t in equilibrium, improving overall outcomes might mean implementing policies that make other markets diverge further from their theoretical equilibrium.

Basically it means that trying to make an outcome perfect in one market might lead to counteracting effects in other market that negate any beneficial effects.

For me this term implies that the equilibrium model of markets is a poor tool for analysis of the economy. However the term implies that market model is first best, and real life is second best - how truly odd to say that.

Bad equilibrium
A assume the economy is in equilibrium. When shit goes bad, assume that the economy is in a ‘bad equilibrium’. WTF does that even mean?

Free market
Really, the ‘free market’ is just a system of highly rigid social institutions that define rights and constrains activities. One frustrating alternative to this phrase is “let the market decide”, which doesn't actually means anything of interest, because markets are merely a product of alternative regulatory constraints. The term creates a diversion from important social issues because it reinforces the assumption that market allocations automatically fulfil social goals, and any interruption of their operation will have costly social repercussions.

The NBN is a great example of this. The social aim is to provide equitable access at a consistent high standard to fibre internet through cross-subsidies between city and country users. The market alternative is that few high value city location will get access to an almost identical service, possibly at lower prices. We decide whether markets are the appropriate tool to fulfil social aims - markets don't decide anything. 

Remember, we can create institutions to produce whatever social goals we have in mind. Market outcomes are great in many circumstances, but they too have social outcome that might justify alternative forms of allocation. 

As if the regular business cycle, the subject of now centuries of economic research, somehow arises from somewhere external to the commercial activities of society.

This Austrian economics terminology is both subjective and confusing at the same time. A school of thought that has its own ideas of creative destruction (implying an unpredictable future and therefore lots of poorly allocated capital) somehow expects all capital to be perfectly allocated or this system will collapse? Unfortunately this term provides an excuse to points the finger for economic woes at whatever your pet hate is at the time (usually government involvement in setting nominal interest rates).

I will let Zac Gross have a go at this one.
‘Reform’ is very sexy word. It is often deployed to cloak policy in feel good vibes and to create an aura of leadership and vision. So everyone in the policy-sphere wants to think of themselves as reformers and many a complete bastard has appropriated this lovely, but overused, title.

1 comment:

  1. If the evidence doesn't fit the theory seek better evidence :-)