Economics

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The dismal science
Economics
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If you're looking for the definite article, see The Economist.
Not a "gay science," I should say, like some we have heard of; no, a dreary, desolate and, indeed, quite abject and distressing one; what we might call, by way of eminence, the dismal science.
—Thomas Carlyle, Occasional Discourse on the Negro Question (1849)

Economics is the study that deals with the production and allocation of scarce resources.[note 1]

The three primary fields of study are microeconomics (the study of small things such as how firms and households operate), macroeconomics (which studies things such as inflation, monetary policy, and international trade), and econometrics (which studies how accurate estimates may be made when applying statistical methods analyzing to social data). Practically all economics today is heavily based on econometrics and empirical analysis. Related fields of study include game theory, behavioral economics, public choice theory, and applied or policy economics. Economists typically disagree on the type of market that should be created by government, the role of state-owned-enterprises, fiscal policy, or tax.

There are several heterodox (non-mainstream) schools of thought in economics, ranging from the right-libertarian Austrian school to World Systems Analysis, which is heavily influenced by Marx's historical materialism.

History[edit]

Economics has existed since the times of the Greeks. But this was mostly in the sense that people tried to put some kind of value to an object. Aristotle and lots of religions also talked about stuff like the evils of interest, ignoring that people pay to borrow money so they can (1) have the money now, (2) because they have a risk of defaulting on that money, and (3) you need to pay people to incentivise them to give up their money and hand it to some other chap, depriving them of the ability to use their money. There was also some stuff in the mediaeval ages, but this was mostly labour theory of value: the idea that something should be valued based on how much time someone spends making it.

But around the 1600s, there was some trash mercantilist ideas floating around Europe. Their big idea was 'why make shit elsewhere when you can make it here' and 'gold is shiny and pretty, so it must be valuable'. So nations decided, basically, to hoard lots of gold. Hoarding gold means that you need to export lots of stuff and import nothing, because when you buy stuff from abroad, you need to give gold to them to get it. The goldbugs have little gone beyond the 17th century. Also, consider if everyone did this at the same time: nobody would import anything . . . meaning that nobody would have anywhere to export to. But more fundamental is the presumption here that trade is bad. In reality, making things where doing so is more efficient means that you have more things. Trade is a means of making that happen. So, as basically every economist since the 18th century has said: Trade is good.

Around the turn of the 17th century, aristocats physiocrats were a bunch of rich landowners who decided to make a theory for why land was the real biggie. Their big thing was that farmers create all the wealth because everyone needs food. I mean, everyone does need food, but people also need things other than food. Their solution to how to grow the economy was really 'grow more food' and pretend everyone else doesn't exist.

Classical economics[edit]

Classical economics really starts around the 1770s. In the English-speaking world, we attribute this to Adam Smith's Wealth of Nations. His big contribution to nations and their wealth was that nations are wealthy because they make more stuff. And trading, division of labour, and allowing people to make things that earn them money, are means to make lots of stuff. Trade is a question of resource allocation. Division of labour is relatively intuitive as well: you need less knowledge to make a single section of something than the whole thing. This means you can throw more people at the problem and make more stuff. The last one, basically, that profits are good, is less intuitive. Profits are good because profits are rewards for providing some good or service that people want to buy. You only make money when people buy those goods or services. That people want those things is an indication of their value to society.

One of Smith's more famous quotations here is that butchers do not provide meat because they are required to or out of the goodness of their hearts. They provide meat because people pay them money to do those things.

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
—Adam Smith

Some of the big ideas around this time is that government interventions are not always good. In the 1770s, government across Europe had legal monopolies for all sorts of industries. And they heavily taxed those monopolies. Today, we see this as a question of raising funds. The governments of that time simply did not have the means of finding out how much everyone should pay. So they made a monopoly that everyone really would have to pay, and then taxed that monopoly as a means to get revenue. Today, we call this an indirect tax. But taxing like this also meant that prices for stuff people need (food, paper, etc.) gets jacked up. And people spend their time not making things, but chasing after the government to give them a monopoly of their own. Special privileges, rent-seeking behaviour, and excessive competition-stifling regulations allocate resources poorly. Plus, the King's plan of raising money with arbitrary forced loans and taking everyone's stuff? Probably bad for business. Instead, it is free markets that do it better.

One of the big questions for economists around the 1870s was about how stuff like diamonds, shiny, are worth more than water, needed for life. The Marginal Revolution explained that: the value of something changes based on how much of it you have. When you have lots of it, like water, it isn't valuable. But when you have only a bit, like diamonds, it is valuable. Economics really got its mathematical expression around the 1890s, with the Marshallian economics. This guy is the person to thank about all the supply and demand graphs. This is where neoclassical economics really takes charge. The introduction of maths means that one ends up with means to study exactly by how much some thing gets better when something happens. But the models around this time are simple and have many simplifying assumptions (turns out solving a 10-dimensional optimisation problem by hand is hard).

Great Depression[edit]

Keep in mind that until around the 1930s and 1940s, when the Great Depression and the Second World War create the need for government statistics about all sorts of things in the economy, there is little ability for anyone measure anything about the economy as a whole (the term 'the economy' as a single all-encompassing thing only emerges around this time too). Instead of counting how many trains are moving around as a proxy for economic activity, government centralisation means that we now know exactly where things are. And which theories are wrong: since you can't disprove them without evidence. However it is, shortly before the Great Depression, there are different undercurrents for different ideas about how the economy works. In the 1890s through to the 1920s, there is considerable debate by economists: one one hand, you have the neoclassicists, who are primarily based in microeconomics (since that is where all the data is) and the Austrians, who reject measurements and claim the non-existence of those measurements is an indication of their impossibility.

The Great Depression happened, which really refocuses economists from a focus on microeconomics. Explaining why it happened is far too complicated for a synopsis like this. And government creates institutions which give them the data to better understand the economy as a whole. There is a myth that all the government spending was good. A lot of it wasn't. For example, Steinbeck in The Grapes of Wrath bemoans government policies that support farmers . . . by paying them destroy their crops and not grow anything. The government didn't create a subsidy for food (so money was spent to make food cheaper and increase farmer profits), but rather, paid people to destroy the food altogether.

The Great Depression lasted a long time. And no country really fully recovered to normal economic times until the Second World War, when government expenditures (and demand in the economy) was so high that the unemployment rate fell, basically, to 0 (a draft did help with that too). Keynesian economics, which was a strong undercurrent during the 1920s, took the lead with macroeconomic models primarily based around the role of interest rates, demand for capital, and the demand and supply of money, as means for explaining the economy. This is one of the core models in mid-century Keynesianism: the IS-LM model (the investment-savings and liquidity-money supply model). Other important ideas around this time are the Phillips curve: the idea that there is a trade-off between unemployment and inflation, i.e. higher inflation means lower unemployment.

Stagflation[edit]

The dominance of Keynesianism continues until around the 1970s, when stagflation happens. Stagflation is the existence of both high unemployment and and high inflation. Mid-century Keynesian economics says this should not happen: unemployment should always trade off with inflation. The predominant explanation for this today is that inflation expectations rose, meaning that the trade-off described in the Phillips curve became less pronounced over time. The cause of those changes in expectations was because of the overuse of fiscal and monetary policies. Empirical research into the Phillips curve over a period of decades supports this explanation (and you should also find such graphs in a introductory macroeconomics textbook).

The Keynesian explanation was more on the lines of a supply shock – the 1970s also had an oil crisis which raised the cost of petrol and energy, making all goods more expensive, meaning that aggregate supply contracted. Contracting aggregate supply increased price levels, causing inflation, and reduced output, causing unemployment. This explanation of the problem is the one taken by supply-side economists. The mid-century Keynesian perspective was rooted in focusing on the demand side (along with a presumption that supply would increase as demand increased).

The result was monetarism and supply-side economics taking the fore. Monetarism put the use of monetary policy as a means to set inflation expectations, price levels, and interest rates. Milton Friedman and the Chicago school were central to promoting these ideas. Either way, whether mismanagement of interest rates or a supply side shock, in the 1980s, the Federal Reserve put these ideas into practice, increasing interest rates to 20 per cent in 1981. It did crashed the economy, unemployment averaging 9.7 per cent in 1982, but reduced inflation from 13.5 per cent in 1980 to 1.9 per cent in 1986. This outcome vindicated the monetarists and supply-side economists.

New Keynesianism[edit]

The growth of the 1990s and the early 2000s under the domination of monetarist ideas also helped to increase confidence. The 2007 financial crisis, and the ensuing real economy meltdown changed that. There is considerable debate on why the crisis occurred, but one of the more dominant explanations is that adopted by the FDIC in its publication Crisis and Response: An FDIC History, 2008–2013, which attributes the cause to a global savings glut, which increased the quantity of loanable funds, lowering interest rates.

As interest costs fell and, in response, the demand for mortgages increased, the funding for mortgages increased significantly, allowing lenders to offer credit to more borrowers. Behind this increase in funding were (1) a heavy demand of investors worldwide for highly rated assets with high yields, and (2) the satisfaction of that demand through the mortgage securitization process, which allowed the financialization of mortgage assets.

This, along with increased international ties and highly leveraged institutions, created significant systematic risk. That risk became visible when new statistics were introduced to measure subprime mortgage risk[2] and credit rating agencies initiated mass downgrades of securities in early 2007. This made many previously marketable securities practically worthless, making institutions holding those securities insolvent. That also created a significant negative wealth shock in home prices, suddenly making many households around the country poorer, directly influencing the real economy.

New Keynesianism, which focuses again on the role of demand, in a set of imperfect and subdivided goods and capital markets, took the fore (and the popular imagination) in arguing for immediate fiscal action. This was signed into law with stimulus bills in the 2007-2009 period. Government action around the world massively reduced interest rates and government spending. And from there, we step into the future, on which no history can be written.

Fundamentals of economics[edit]

What represents a fundamental truth in economics can be difficult to determine, as many theories have proven difficult to test. However, there are some ideas accepted almost universally, except by cranks. Here are ten commonly accepted principles taken from the top-selling college economics textbook, Gregory Mankiw's Principles of Economics:[3]

  1. People face trade-offs
  2. The cost of something is what you give up to get it
  3. Rational people think at the margin
  4. People respond to incentives
  5. Trade can make everyone better off
  6. Markets are usually a good way to organize economic activity
  7. Governments can sometimes improve market outcomes
  8. A country's standard of living depends on its ability to produce goods and services
  9. Prices rise when the government prints too much money
  10. Society faces a short-run trade-off between inflation and unemployment

These touch on most of the major concepts and problems addressed in economics — the scarcity of capital, resources, and labor, the concept of absolute and comparative advantage that leads to trade, the use of the market as the basis of exchange, the disparity between rich and poor nations, inflation, and government intervention.

Strong assumptions and economics[edit]

Their definition of 'rational' is your definition of 'prophetic'.
— - Steve Keen[4]

The stronger an assumption, the less realistic it tends to be. The better the economic model, the more it relies on weak assumptions. Some assumptions made in specific areas of economics have come to be viewed as economic "fundamentals," mostly due to crankery and political hacks. Cranks make a big deal of these assumptions in order to create straw man arguments criticizing economists for making assumptions that any ordinary person knows is unrealistic. Often, the reality is that these issues have been the focus of much attention among economists, to the point where the finer details can be difficult to communicate. Other assertions come about as a way to defend certain political ideologies.

It should be kept in mind that many modern economists rarely deal in theoretical models, though they certainly capture the public imagination. Most dissertation or extremely long papers generally do massive amounts of empirical and statistical analysis to prove that some kind of effect exists. Then, a theory is introduced as a means to explain an effect that is observed by empirical analysis. There are lots of seminars in the academic world of economists. If you presented a model without empirical analysis showing the existence of the effect your model purports to explain, you'll be laughed out of the room.

These assumptions include:

  • Agents possess perfect information – A common assumption in the economic models presented to undergrads, but by no means accepted by economists as an accurate description of humanity. Outside of strawmanning in the realm of reality, modern economics routinely uses imperfect information models, and while introducing imperfect information often adds a level of strategic interaction to economic models that make them difficult to solve with elementary calculus, most graduate-level economic research dismisses perfect information models out of hand.
  • Agents are perfectly rational - An excellent example of the issues in using jargon. The definition of "rational" in economics, and in the rest of the world, are very different. Rationality in economics refers to the type of preferences a person exhibits, whereas the common usage of rationality describes the level of clarity present in ones thought. Certain fields of economic study, such as behavioral economics, have spent significant amounts of time testing the boundaries of this assumption.
  • Firms are perfectly competitive - Mostly a misconception by those that do not expand their economic education beyond Econ 101. Perfect competition is an assumption that, like the assumption of perfect information, eliminates a level of strategic interaction between agents and firms. Economists rarely think of this as a good description of markets, so many modern economic models, such as the macroeconomic models utilized in New Keynesian economics, utilize some form of monopolistic competition.
  • Government activity is always incompetent or harmful (including lowering taxes always raising tax revenue) - Many simplistic models of government taxation show that poorly executed taxes may lead to a dead weight loss for the economy. While this is sometimes true for marginal taxes, any losses caused by levying the tax should be weighed against the greater economic efficiency and social benefits they provide. In theory, Pigovian taxes, which are marginal taxes designed to offset the effect of negative externalities, can improve social welfare (and have been advocated across the political spectrum). Many other examples of welfare-improving government intervention exist.

Economics and prediction[edit]

At the macroeconomic level economics is lumped with a school which can't work but we know why, and a school which does work but we don't know why. At the microeconomic level economics is stuck between limited reports on real-world behaviour in very specific sectors (e.g. the relationship between executive performance and pay), and psychological deductions about universal tendencies. At both levels, Good/non-crank economic predictions shy away from the precise, such as "we will have a 5% dip in unemployment next month," and towards the general, like "If we don't increase the Social Security retirement age today, we will have a serious problem with destitute elderly sometime in the future."

The lack of black and white explanations can be frustrating to cranks of all sorts, who would like to take this as a sign that their particular pet discipline offers the best possible explanation for the world we see today. Unfortunately, these cranks are typically unwilling to do the hard statistical work needed to empirically validate their theories. Economists do have a wide variety of statistical tools to employ in order to test the quality of different economic models, but as in all social sciences what you're measuring is as important as it is subjective. For instance Chicago School believers in Homo economicus would attribute a worker's productivity solely to pay, whereas behavioural economists would also consider things that can't be quantified as easily (e.g. relative pay, job satisfaction, workplace culture).

Pseudo-economics[edit]

A friend of mine once said: You know what the problem is with being an economist? Everyone has an opinion about the economy. No body goes up to a geologist and says, 'Igneous rocks are fucking bullshit.'[5]

A large and diverse body of crank economic ideas exists, ranging from people who still adhere to quaint and archaic theories of the past (see below) to those ideas which still enjoy widespread popularity today, such as name it and claim it (aka. God will make you rich), pyramid schemes, and esoteric conspiracy theories about the Federal Reserve. The Liberty Dollar is a cranky libertarian scheme to set up a competing private-minted currency. Bitcoin is much the same.

Other notions such as the Laffer Curve are valid economic theories. However, ideas like the Laffer curve (i.e. that at a certain high level of taxation, government revenues can increase by lowering income taxes, due to expansion of the tax base) have been long misapplied by some who don't have a full understanding of these theories. This is especially the case when empirical research into the Laffer curve puts the point at which lowering taxes can increase revenue somewhere near 70 per cent. Often solid economic thought is twisted to fit a political agenda. Taxation and government intervention are two common targets.

Schools of thought[edit]

A broad field determined by its many different schools of thought, it is, at its core, the science of material production, consumption, scarcity, supply, finance, and monetary policy. That being said, its status as a science is pretty much determined by the individual model of normative analysis. In some cases, it is more of a Social science, as is the case with Austrian School, which has historically eschewed any mathematics as the basis of market analysis. While modern Austrians seem to be leaning more towards a behavioral-based approach based on logic-based math, Austrian economics is soft even for a social science. Behavioral economics suggests that the market is defined by individual rationality based on specific situational circumstance, which is ultimately affected by one's choice whether consciously or subconsciously. This would probably fit into the more general social science category.

Now, it is probably best to address yet another economic school that demonstrates a lack of empiricism. Of course, we're talking about good ol' Marxism, which, though most people agree on that it's not so bad-looking on paper, is an even crankier version of economic analysis than Austrianism, seeing as its pretty much just a set of proposed ideals as opposed to a presentation of fiscal solutions. Marx, though technically an economist, was really more philosopher than scientist, both as a political and moral theorist (although the three often go together, and, in Marx's case, the heart of his philosophy was collectivism). Eventually, at some point somewhere, people actually decided to add a sensical economic system to incorporate with the communist political ideology, generally referred to as socialism. In Soviet Russia, economy helps you everything sucked unless you were a rich white oligarch. Basically, both the USSR's economic policy, which involved near-total government subsidisation of all facets of production and distribution (with most of it going to the elite, of course), and the ironically self-interested motivations that drove people like Lenin and Clark Kent that OTHER "Man of Steel" ultimately resulted in the Soviet's union becoming one of the most oppressive forces of the 20th century.

Unlike the market economy, in which, aside from protectionism and the imposition of tariffs, the public and private sectors are essentially divorced, 20th century communism was the result a loving marriage between economic structure and the state, where they both relied on the other. This unsustainability led to the decline of the Eastern Bloc's supremacy. Ultimately, the entire system would implode as a result of Western markets, when the One True Lord and Savior famously Reagansmashed the communist economy after feigning a rapid military buildup, causing the reds to freak out, do the same thing, and then bankrupt themselves. By then, pretty much everyone realized what a mess that traditional standard socialist model was. Even the Mao Dynasty changed its economic model after witnessing the flaws of absolute socialism, implementing a market, or, rather, corporate, element as well, albeit highly subsidized. Other than that, the Marxist-socialist model proved to be an absolute trainwreck.

This is another example proving of how economics is, indeed, a legitimate science. The implementation of (mathematically feasible) normative models to a society is basically the use of the Scientific Method. The overall success of the systematic determination in market functionality, or the efficiency of distribution and allocation of resources, is evidence of a proven and objective theory. Pretty much every communist country of the past century collapsed largely due to economic unsustainability, and those that are still around, aside from a quasi-neoliberal China, have terrible economies (i.e. North Korea).

While there are those economic models that would qualify in the "social science" category, or just as downright arbitrary nonsense, there are some (usually consequentialist) models that actually practice economics as a hard science, driven primarily by statistics and empiricism. Two prominent models that make use of this empirical approach, as well as rational determination of market transaction, are Chicago-style Neoclassicism and the Keynesianism system. The former, which until recently was the pure basis of the American economy, favors free trade and a market-friendly approach to fiscal policy with a preference for privately-solved solutions to issues, whereas the latter essentially favors self-sustenance of the economy through the buildup of a nationally-subsidized industrial complex as a means to control both unemployment and inflation at once.

Professor Chang's one-sentence schools guide[edit]

  • Classical: The market keeps all producers alert through competition, so leave it alone.
  • Neoclassical: Individuals know what they are doing, so leave them alone -except when markets malfunction.
  • Marxist: Capitalism is a powerful vehicle for economic progress, but it will collapse, as private property ownership becomes an obstacle to further progress.
  • Developmentalist: Backward economies can't develop if they leave things entirely to the market.
  • Austrian: No one knows enough, so leave everything alone.
  • (Neo-)Schumpeterian: Capitalism is a powerful vehicle of economic progress, but it will atrophy, as firms become larger and more bureaucratic.
  • Keynesian: What is good for individuals may not be good for the whole economy.
  • Institutionalist: Individuals are products of their society, even though they may change its rules.
  • Behaviouralist: We are not smart enough, so we need to deliberately constrain our own freedom of choice through rules.[6]

Archaic ideas that still get brought up occasionally[edit]

  • Austrian school: A school of economic thought from the early 20th century which rejects empirical testing in favor of narrative 'praxeology' aka the fantasy football of economics. That's the wonder of the Austrian Preschool, you can skip learning nasty mathematics and get right to praxing out whatever you wish. Overall, they're just highly-paid fortune tellers.
  • Bitcoin: Everyone outside the echo chamber has long realized that it offers no advantages over traditional currency. The notable exception being illegal transactions. That's the only thing, other than rampant speculation, keeping it alive—for now. Criminals have already started looking for solutions that offer real anonymity.
  • Chicago school: Also known as fresh-water economics to distinguish it from salt-water economics, practiced by those living near or on the U.S. coasts, a school of economic thought associated with Milton Friedman and his followers at the University of Chicago that emphasizes the role of money (monetarism). This distinction is now outdated, since the adherents of both the Keynesian and Chicago schools have adopted each others' ideas.
  • Cyclical theory: Trying to predict how the stock market will go in the future by the Kondratiev Wave or Elliott Wave.
  • Distributism: A failed attempt at forming a new economic ideology in line with Catholic social justice ideas, using an 1891 Papal encyclical as the basis; comes out something similar to the more recent "back to the land" sentiments.
  • Galambosianism: Intellectual property rights taken to its absolute, and absurd, conclusion.
  • Georgism: A belief that income gained purely from extraction of natural resources and monopoly over properties of nature should belong to society in common, but that income from things created by labor and investment should ideally be kept private. Problematic in that it still requires inputs and investments to extract things from nature. Basically, there is no clear line.
  • Goldbuggery: A belief that fiat currency is responsible for most contemporary economic ailments, and that currency ought to be backed by a commodity, namely gold. Variations of this doctrine replace gold with other commodities (oil, for example) while exhibiting the same basic mindset. Practically no reputable economist will support this, simply because of the lack of control on the money supply and the reality that growth will cause deflation (devaluing money and reducing incentives to spend it, thereby reducing aggregate demand).
  • Laissez-faire: Almost no economists still hold to this, if only because of the understanding that the government needs to deal with externalities. Moreover, a perfect free market depends on perfect information, and people are ignorant, as any person who walks around a given city for a few hours can discern.
  • Lyndon LaRouche's ideas. They involve quite a lot of protectionism (i.e., 19th century economic thought)[7] and a harsh attack on globalism, the IMF, or anything else developed in your lifetime. He also has a rather hilarious hatred of both corporate interests and international institutions while supporting constant government intervention, then saying that governmental intervention is fascist.
  • Marxism: The original Marxist economic theory was based on 19th-century concepts such as the labor theory of valueWikipedia's W.svg and the tendency of the rate of profit to fall.Wikipedia's W.svg Due to the cultish persistence of Marxism, these ideas still get brought up frequently.
  • Social Credit: C. H. Douglas unveils the mysteries of consumer power using complicated mathematical formulas, like consumers exercising their power at the marketplace will direct the behavior of producers. Ya think?
  • The Townsend Plan: Nobody seriously advocates this today (chiefly because a more workable, non-insane version was eventually created in the form of Social Security), but it is occasionally mentioned as an example of the economic woo schemes that flourished during the Great Depression.

See also[edit]

External links[edit]

Notes[edit]

  1. Scarcity, in economics, just means you have to pay for it because there is not enough for everyone to have all they could possibly want for free.

References[edit]

  1. Crisis and Response: An FDIC History, 2008–2013, https://www.fdic.gov/bank/historical/crisis/chap1.pdf, page 9
  2. Crisis and Response: An FDIC History, 2008–2013, https://www.fdic.gov/bank/historical/crisis/chap1.pdf, page 20
  3. 10 Principles of Economics, Wikiuniversity
  4. Steve Keen, Understanding Economics featuring Dr. Steve Keen - Part 2 of 4 8:50
  5. https://www.reddit.com/r/badeconomics
  6. Ha-Joon Chang, Economics: The User's Guide (London, 2014) pp.115, 120, 127, 133, 138, 142, 145, 151, 156
  7. "LaRouche Advises Democrats On What They Must Do"