According to Krugman (1997) there are three kinds of economic writing, they are: Greek-letters, Up and Down, and Airport. The first type, Greek-letters, is mainly academic writings, which very often involve some form of mathematical formulation. This form of writing is incomprehensible even to the average intelligent person because it involves specialised knowledge of the subject matter. To make matters worse, it is often not written in plain words but in pages and pages of mathematics which makes it inaccessible to the general public. Seen in its proper role, as a servant, not a master, mathematics is an invention which can increase enormously the productivity of thinking (Ormerod, 1994). However, he warned, economics must drive mathematics, rather than the other way round. The second type, Up and Down, is what we see in everyday financial news reporting. Reports like ‘the Dow Jones moved up XXX points within fifteen minutes of market opening’, ‘share price of XXX suffered a setback of XXX percent due to announcement of worse than expected quarterly profits’ etc. The truth is, unless one is directly involved or waiting for these reports, they are downright boring and make excellent lullabies. The third type of economic writing, Airport, is on the so-called Best-seller’s list. They are for those bored businessmen who have nothing to do in the airport while waiting for a flight. These types of books usually have an eye-catching title and tend to dramatise whatever economics they are writing about in order to chalk up sales. In these books, it seems only two extremes exist, an end-of-the-world Armageddon-type economic situation and economics in the perfect and ideal world. Full blame cannot be put onto the authors for sensationalising economics because a book that says economic policies can sometimes work and sometimes not work, given a certain sets of conditions, would probably not make it on the Best-sellers’ List. Finally, Krugman conceded that there is not much economic writing today to attract the intelligent reader who does not want to do a Ph.D. Galbraith (1987) added ‘It must be said, much past writing on the history of economic ideas has been aggressively dull.’ So has economics isolated itself from the rest of the living world?
Economists often seek to mystify rather than enlighten the general public, and nowhere is this accomplished better than economic data[1] (Ormerod, 1994). Mark Twain once defined three kinds of liars, ‘Liars, damn liars and statistics’. For example, the economic accounting systems by which economic growth is measured make no comparable adjustment for the depletion of social and natural resources. The clean-up costs of the oil-spill caused by Exxon Valdez accident in Alaska would count as net contributions to economic output. This is simply absurd because it defies logic. Disasters, caused by man or nature, are tragic for both the people and the environment, but yet in economic terms, they are often counted as good for the economy. In this case, economic accounting principles must change in order to accommodate plain and simple logic.
Rationality is another economic concept that proves to be very elusive. In modern economics, each individual is a Rational Economic Man that seeks self-interest with guile. Similar to the view of Mrs. Thatcher, economic sees no such thing as society, but only individuals that constitute it. But as mentioned before, according to Adam Smith, there is such a thing called society. For Smith, the value system of the society acts as a restraint on individual behaviour. In orthodox theory, consumers have preferences that are represented by a utility function, and they choose in a way that maximises their utility subject to a budget constraint. Similarly, firms are modelled as profit maximisers subject to constraints by their technological production possibilities set. To any normal persons, these sets of conditions can be a bitter pill to swallow because consumers do not go shopping with their utility curves in mind, either does the manager who negotiate a deal would necessarily put profit as the first priority[2]. This is not to say that economic models built upon the Rational Economic Man is always wrong, but the real world is far more complex than economic theory allows. For example, modelling expectations is very much an area of controversy, simply because there is a variety of alternatives other that rational expectation. To name a few, there are static expectations, adaptive expectations, extrapolative expectations, regressive expectations, perfect foresight etc., all of which can be modelled mathematically. Some of these models do not have any economic justifications, while others have a theoretical viewpoint. However, it does not mean that expectations are not time-variant, or in other words, individuals may change their expectation model (if they have one) from time to time. But what it does mean is that the Rational Economic Man in economic theory does not apply to human beings in a society.
Conventional economic theory still assumes that the national economy of a sovereign state as the primary unit for effective economic policies. However, in reality, there are four economic units that exist, which are inherently intertwined with each other. First, and obviously, the National State, where the traditional definition of national boundary applies. No government would be willing to relinquish the control over the ‘national’ economy; even though, increasing the effectiveness of the overall decision-making process of the next economic unit overshadows economic and political policies of the sovereign state.
Second, looking at the Regional Economic Unit, there are two spheres that need clear definition. The first sphere is the Supranational Economic Unit. When we look at the world map today, we can easily distinguish pockets of these regional economic units. In Europe, we have the European Economic Community (EEC); in Asia, there is the Asia-Pacific Economic Community (APEC), Association of South East Asian Nations (ASEAN) and the Asia Free Trade Agreement (AFTA); in North America, there is the North America Free Trade Agreement (NAFTA); and so on. Moreover, in this post-World War II and post-Cold War era, it makes more sense for nations to put more emphasis on economics, and especially within a certain region. With the break-up of the Warsaw Pact, NATO (North Atlantic Treaty Organisation) now looks like a dinosaur biding its time because of its non-economic orientation. The second sphere is what Ohmae (1995) would define as the Region State. Region states are economic not political units. They may lie within the borders of an established nation state, but they are powerful engines of development because their primary orientation is toward – and their primary linkage is with – the global economy (Ohmae, 1995). Region states make effective ports of entry for the nation state into the global economy and for the firm wishing to gain entry to the domestic market. Therefore, these region states must have the necessary infrastructure in communications, transportation and professional services (e.g. financial services) needed to participate in the global economy. It would be almost nonsensical for a firm to target the whole of China when launching a product, given China’s varying demographics between its cities/regions. Therefore, the logical point of entry would be to first target or concentrate its sales in a certain city/region (e.g. Shanghai) where the firm would achieve the economies of service. This is the only sensible approach where the strategy is to build an organisation for a region state alone, with the capability to build future linkages to other regions states if and when the management decides to expand into other region states.
Third, the global financial economy, where money, investments and interest rates dominate. With the advent of modern information technology, there are no real boundaries anymore. It was in the last twenty to thirty years where we saw the emergence of numerous financial products like derivatives, real options etc that was unheard of previously, made possible by technology. Finally, there is the transnational enterprise (TNE), which I find the most curious out of the four economic units. Curious because the TNE is a unit that seeks to maximise profits and/or markets as its only primary motive, almost anything else seems to be secondary, and this is all in the name of the shareholders’ value. Curious because the TNE is not accountable to the general public and the interest of the living environment. Given that some of the top TNEs have sales turnover or market capitalisation greater than Gross Domestic Product (GDP) of many countries, the TNEs simply cannot afford to be ignored. For example, the total sales of the Mitsubishi Corporation is greater than the GDP of Indonesia, a country of more than 200 million people, the fourth most populous country in the world, a country with an enormous wealth of natural resources. In 1999, If you could empty the wallet and pockets of every person in the United States, turn upside down the register in every store, smash the piggy banks, look under the mattresses and behind the couches, and pluck every dollar from every foreign black market, you would end up with US$450.6 billion in loot[3]. That booty would still not be enough to buy Microsoft Corp. The software company ended 16th July 1999 trading with a market value of US$507 billion, the first time any company has passed the half-trillion dollar level and only eight countries in the world have economies larger than the software giant[4].
The last three economic units, the regional economic unit, the global financial economy and the transnational enterprise, arguably, can or have the potential to undermine the effectiveness of economic policy-making and even the political status of the first economic unit, the sovereign state. This is the reality, something we cannot deny or ignore, but this is not the scary part. The scary part is there seems to be no transnational laws enforced by credible global institutions to dictate what these economic units can or cannot do.
In the present economic environment, in order for an economic theory to function properly, it must be able to integrate the four units mentioned above. The theory must also have a unifying principle(s) which can fairly predict and control the behaviour of the five spheres of micro-economy, macro-economy of the sovereign state, macro-economy of the regional economic state, the transnational enterprise economy and the world economy. This is an impossible task, given the magnitude of each sphere, and on top of that the theory must clearly define the inter-relationships between each sphere. These relationships are simply too complex to be analysed…too complex to be described…too complex to be forecasted. Unfortunately, an economic theory needs to simplify. If no such theory is formulated, we may be looking at the end of the road for ‘economic theory’. In its place, there would only be economic theorems, which are reactive rather than, proactive in nature. They would only explain be able to explain economic phenomenon on hindsight and solve specific problems, rather than serve as a foundation on what economic policies are based on.
Different schools of economic thought would obviously have very different ideas of what the government should or should not do for the economy[5]. But increasingly, governmental economic policies are becoming more ‘preventive’ or ‘proactive’ that would resist economic crises rather than managing or curing them. In business terms, this means that economic policies will no longer put emphasis on controlling the ‘weather’ of its economy, but rather they would be aimed with the purpose of maintaining the ‘climate’ of its economy. There is a simple analogy, controlling the economic weather would mean that when a person gets sick, a doctor would prescribe some medicine to treat the illness according to the symptoms. Maintaining the business ‘climate’ means that the doctor would advise the patient to take some form of preventive health measures like ‘eat more fruits, exercise more, have a healthier lifestyle’ to improve the overall health, so that the probability of illnesses striking decreases. Optimally, economic policies should be able to handle both the ‘weather’ and the ‘climate’ because not matter how healthy a person is, he or she will get sick at some point in their lives. Therefore, it is important for an economy not only to maintain a healthy climate based on some fundamentals, but also be able to prescribe the [6] form of medicine so as to get the economy out of its rut when a crisis happens. Economic policies are bound to be doomed if they are able only to do one and not the other; this can be reflected by non-re-election of the government in a democratic society or violent overthrows in any form of society.
No economic theory can fully explain the main economic events (e.g. the gross over-valuation and under-valuation of the US dollar in the 1980s, levels of inflation and unemployment) that happened from the mid-1970s to the late 1980s. There is no need to detail the events that happened during this period here; any standard economic history text would suffice. All the talk of the ‘natural unemployment rate’, ‘inflation rates’, ‘supply of money’, ‘Thatcherism’, ‘Reaganism’ and all that jazz in this period. In the meantime, while the economists from different schools battle it out, reality is outgrowing economic theory at a tremendous pace. It is no wonder that there is a sense of apathy in the general public towards economics because they sense that economic theory can no longer explain the new realities.
For all that is said and done, is economic theory is dead? The answer is an emphatic ‘NO!’ If it was, how can we explain its popularity? Why would I even bother to study economics in the first place? However, survivability of economic theory depends on its ability to learn from its past experiences, its ability to live in the present and its ability to alter its course to adapt to the future. For Adam Smith, observations from the real world comes first, economic theory comes second. Economics must shed its holier-than-thou image by returning to this principle, rather than sticking to some absurd unobservable concept that even though may make ‘economic sense’, but not common sense. In order for economics to survive, it needs an audience and a paying one at that. If economists surround themselves with economic theories and concepts without truly relating to the ‘real’ world, the ‘real’ world (i.e. the audience) will eventually turn its back on economics. The last thing the world really needs is an armchair economist talking about the ills of the world using economic jargon, while in the meantime, millions in Third-World countries go to bed hungry.
Bibliography:
Galbraith, J. K., 1987, A History of Economics – the Past as the Present, Penguin Books, London.
Kreps, D. M., 1990, A Course in Microeconomic Theory, Harvester Wheatsheaf, Hertfordshire.
Krugman, P., 1997, The Age of Diminished Expectations, 3rd ed., The Washington Post Company.
Ohmae, K., 1995, The End of the Nation State, Harper Collins, London.
Ormerod, P., 1994, The Death of Economics, Faber and Faber, London.
[1] For a general discussion on the measurement of a country’s prosperity, Ormerod’s (1994) ‘The Death of Economics’ seems a good place to start.
[2] Kreps (1990) summarised the three rationales behind using rationality. First, consumers are presumed to act as if they maximise their utility function. However, he does admit that a lot of data collected falsify these models. Therefore, we have to fall back onto the second presumption that individual behaviour is not important; instead the aggregate of many individuals matter. The third line of defense is the most subtle but nevertheless important. It presumes that we can still learn and gain insights from models that suffer from systematic violations that do not cancel out.
[3] Source: Washington Post, Bloomberg News, 19 July 1999.
[4] Source: The Straits Times, Singapore Press Holdings, 19 July 1999.
[5] There is simply not enough space here to outline the different schools economic thought in this essay; it would need more than a book to do it. Therefore, I hope to get away with it from just one sentence.
[6] Again, different schools of thought would have very different prescriptions to one economic situation. There is no one universal treatment or cure for an economic crisis. Like in the field of medicine from different cultures, there are very different ways of treating one single illness and there is no one ‘correct’ medicine.
Armchair Economist 