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The state of economics-I, The state of economics-II
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- The future of economics: Year 2021 is the right time to ponder upon the future direction of "economics". Nearly 20% of this century is gone already. Time to question the method of economics.
- The method in economics: Till date, four major methods have evolved. First, till the 1980s, someone would give a theory, and then prove it with logic and maths. The Nobel Committee also approved of it, despite most of these proofs being in the abstract, with conditionalities ("if this happens, then this follows").
- Data driven governance: When governments started collecting more data, a new age started, as proving a theory now was based on econometric techniques (not abstractions alone). Now, the biggest problem that economic always targeted was to be solved using data techniques. This was the second method.
- Biggest problem of economics: It is "causality", or the "post hoc ergo propter hoc" problems.
- Post hoc ergo propter hoc in Latin means 'after this, therefore because of this'
- It is an informal fallacy that states: "Since event Y followed event X, event Y must have been caused by event X."
- So the regression-dependent economist was born, dependent on data. (Third method)
- What was ignored was that human data is context-specific and results aren't fully replicable. Abstractions from reality gave way to approximations to reality.
- Many mistakes were made, and focus shifted to experiments.
- Experimental design for theory: It did work, but the post hoc problem wasn't solved. Then the fourth method - RCT - was born (randomised control trials). Experiment first, theory later. Take two groups of people, and observe their behaviour, subjecting one of them to slightly different conditions.
- Which is best: Of the four, no one knows which method worked best. This is so since economics believes in "induction", that it is right to go from 'the particular to the general'. Karl Popper discredited this ages ago! Consider the logic - since all swans I have seen are white, all swans must be white. This fatal mistake is what economics has been making.
- Deduction: It goes from general to the particular. So all inflations are due to excess money supply, and all have an added immediate reason too (e.g. oil price rise, droughts etc.). But why are economists not able to induct the new realities (3 of them) into formal analysis?
- Three new realities:
- Microeconomics - It studies four markets: land, labour, capital and product (produced by combining of first three). Technology augments this combining, in a process called productivity. Today in 2021, all except land are in excess supply - Labour due to huge population growth, Capital due to no gold peg for currencies, Output as these are cheaper, and Technology due to IT revolution. Sadly, economics works on scarcities, and not excess (which is the reality). Goal is to reduce both unemployment and inflation, which are mutually contradictory. In markets for jobs, food and finance, risk and uncertainty have gone down hugely (two main pillars of microeconomics). Food is plentiful, jobs are in gig economy, and finance is cheap. A total reinvention of micro-economics is now needed.
- Macroeconomics - This branch of study where entire economy is studied as a whole arose after the Great Depression of 1929-37. Before it, automatic adjustment of markets was assumed, but it didn't happen. So US President Roosevelt and Germany's Adolf Hitler decided that their governments will help markets adjust, and huge public programmes began in 1933. These were validated by JM Keynes, in 1936, using logic, not data. The two leaders were doing RCT in reverse! After 1945, policy turned to public investment as a stabiliser. Taxpayers' money was spent, uncertainty was reduced, and credit taken if it worked (else the next govt. would clean it up). India's Modi govts have done this since 2014.
- Politics - Today, monetary and fiscal policies are essentially political, with an overtone of intellectual rigour (earlier it was the reverse). But political objectives of macroeconomics are minimisation of unemployment and inflation. (and not Keynesian maximisation) This political objective is not consistent with economics. Why not? Because short-term instruments like fiscal and monetary policy are being used (that need daily adjustments) to manage long-term goals (unemployment and inflation).
- Road ahead: The six variables studied by macroeconomics - interest rates, exchange rates, balance of payments, fiscal deficit, inflation and unemployment - move opposite to each other. It is nearly impossible to do this. The need now is to stop thinking about scarcity, and focus on abundance. The old Keynesian thought of scarcity has to be dumped, and a new approach created for 80 years of the 21st century.
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