September 15, 2009

Krugman on the state of economics

Posted in Miscellaneous at 3:06 pm by Eamon Aghdasi

I just got around to reading Paul Krugman’s New York Times Magazine article, “How Did Economists Get it Wrong?“. Brilliant breakdown of the shortcomings of economics as a social science as it stands today. If you haven’t read it already, I highly recommend it.

Here’s a bit that I think summarizes the article:

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

I’m definitely on board with this argument (let’s face it, it’s easy to recognize what Krugman’s talking about now that we’re on the heels of crisis, and much more difficult before the crisis’s onset). There is value in the “elegance” of an economic model, but I think too many economists have an obsession over elegance. I realize it allows for models that, had they not been oversimplified, would lose their usefulness. The stumbling block is not the simplicity of the models themselves, but the tendency to actually believe that the model is perfect in practice, that for instance, human beings are perfectly rational beings in real life.

September 1, 2009

The missing costs of advertising

Posted in Rationality and consumer choice at 3:07 pm by Eamon Aghdasi

CAUTION: Viewing Newport ads may be hazardous to your perception of reality

CAUTION: Viewing Newport ads may be hazardous to your perception of reality

For a while now I’ve been wondering about whether or not certain types of advertising distort consumer choices and welfare. We all know that a lot of advertising sometimes bends the truth and attracts potential buyers indirectly (for example, linking the desire for beautiful women to the desire for beer). But is this actually bad? A lot of us jump to conclude that the answer is yes, based simply on what we see in the news or in our own neighborhoods. The sub-prime mortgage crisis, which among other things succeeded in exposing apparently dishonest practices in lending, certainly added fuel to this fire.

Advertising’s power to sway consumer choices is nothing new. If you’re interested in this sort of thing, I strongly recommend a documentary called The Century of the Self, which chillingly chronicles the nearly century-old history of persuasive advertising and marketing. At its center is the figure of Edward Bernays, a nephew of Sigmund Freud and one of the fathers of public relations. Bernays believed strongly that the actions of the masses could be controlled for economic or political purposes, through the clever use of advertising messages that tapped into normal human desires and fears. In Bernays’s most famous intervention in 1929, he arranged for a handful of attractive young women to march side-by-side in New York’s Easter Parade and, simultaneously, light up what they called “torches of freedom” as a demonstration of women’s rights. Amid extensive newspaper coverage and the resulting dialogue it generated, the simple plan helped turn smoking among women from an unfeminine habit into a symbol of equal rights and female independence.

The skeptical economics student and devout believer in the rationality of human beings may still not see the cause for alarm. After all, aren’t human beings rational actors capable of maximizing their own welfare via their own choices? No matter what advertising messages the individual is exposed to, he or she sensibly processes all the information and acts in a way that maximizes welfare. In this world, advertising is simply the provision of information and a useful tool for signaling, and the only downside is the apparent waste that a “good” product has to go through to prove itself and create a separating equilibrium from the rest.

Unfortunately, the reality is that economics really doesn’t make this claim about human nature, and the concept of “rationality” is more a mathematical arrangement that allows the platform of microeconomics to work in any useful way. In fact, economists (along with psychologists and others) have created an entire branch of their own social science — behavioral economics — to find the places where human beings tend not to behave rationally, as classical economics assumes for the sake of creating models.

Is there any basis in economics to question the potentially detrimental effects of advertising, then? I think there is. Read the rest of this entry »

August 17, 2009

Was Max Weber right… at all?

Posted in International development at 6:27 pm by Eamon Aghdasi

max_weber

Max Weber, author of The Protestant Ethic and the Spirit of Capitalism, and inspiration to lazy economists everywhere

For a long time I’ve been fascinated by the idea that economic outcomes might somehow be related to cultural and ethical norms. Do societies which value work tend to be wealthier or develop faster? What about societies in which people more commonly believe in women’s freedom? What about those in which individuals look more favorably on democracy, or more critically at corruption and bribery?

Economists and social scientists have grappled with these questions for about a century. The topic goes as far back at least as Max Weber, who in defining the “Protestant ethic” argued that Protestant societies, by virtue of their religious and cultural history, were better equipped to succeed than Catholic societies. Soon after Weber, Werner Sombart published a book called The Jews and Modern Capitalism, in which he argued that Jews had qualities that allowed them to succeed in capitalistic environments.

More recently, economists have pointed at culture as a burden in some countries’ economic development. For better or worse, this cultural argument for development stagnancy has fallen flat on its face in recent years. The lone fact that Ireland and India were two common examples supporting the culture-as-economic-constraint argument now render this line of argument ridiculous. Amid India as one of today’s shining examples of emerging market performance, the phrase “Hindu rate of growth” is now used only to giggle at economists’ lack of foresight. Similarly, the once disappointing Ireland now finds itself with a higher per capita GDP level than the United Kingdom.

While many economists now focus on the role of institutions in development, few seem interested in revisiting things like culture or religion as explanations for development outcomes. My sense is that the cultural arguments have been shot down so consistently and so embarassingly over time that few academics want to risk being the next one to look stupid by bringing it up again. There’s also the unfortunate racial motivation for some of these studies in the past, which renders more modern versions of this research as suspicious. Read the rest of this entry »

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