How can economics become more useful for policy?

Yesterday I attended the Centre for Science and Policy Annual Conference 2015. There were a range of different discussions about how government can make better use of expertise and evidence from the humanities. When discussion the issue of improving communication of useful insights, a question was raised how it came that economists could get away with being so useless.

The answer provided by Barry Eichengreen was that there are no incentives to change to be more useful. This is the usual answer you get from economists when the question is asked. But I would like to provide a more nuanced answer in this blog. First of all it is true that economists have a reputation for being useless, but this does not imply that all economists are useless, or that all economic research is useless. It merely implies that a sufficient number of students have had the experience of being taught economics by lecturers and professors who made no attempt to make a real world connection. However, there is quite a number of economists who do make the connection and illustrate how economic principles can help us understand what is happening in the real world, as well as how we can design more effective policies.

There are some problems with teaching and research in economics, but there are some very insightful economists out there who take their role to be useful to society seriously and who also endow their students with a better understanding of how the real economy works. So not making the connection and explaining to a student what the point of the model is in a real world context, tells you more about that particular professor than it tells you about the extent to which economics as a discipline can be a useful tool.

Models are useful tools for making a particular point clear, and it is our job when teaching to make the applicability as well as the limited applicability of the models clear to the students, and in our research to continuously improve these tools to enhance their applicability to the real world.

Realising Value: The unselfish core of economics

Rubinstein (2006) noted that one of the most contentious assumption in mainstream economics is that of selfishness. He further discussed evidence that students of economics become more selfish by studying economics and questioned whether this was the right path for the subject to follow.

Many years have passed since his criticism. However, Rubinstein is just one in a whole string of distinguished economists who have pointed out the problem of basing economic modelling on empirically flawed assumptions. I remember as an undergraduate in the late 1980’ies how our lecturer in economic psychology was providing us with evidence that showed that the assumption of the selfish rational utility maximising economic agent was flawed, and how the lecturer in micro economics was trying to defend the model with Friedman’s ‘as if’ assumption. However the point of the evidence is that consumers do not even behave as if they were selfish agents.

Whilst evolutionary biologists have responded to the evidence by formulating new theories such as group selection to explain the optimality of cooperation and sharing over selfishness for survival, economists are still teaching first year undergraduates the same material as they taught 30 years ago, despite even more accumulated evidence of the flawed assumption of selfishness.

Given the increasing body of evidence of fairness and cooperation in the animal kingdom which is mainly due to synergies that can only be realised that way, the question to ask is why selfishness became the norm and deviations from it were considered puzzling.

We shall see that the answer to this question is quite interesting. The idea came from Adam Smith who was an 18th century moral philosopher. It should be remembered that in his time, i.e. the 18th century, selfishness was deeply resented as it was considered not to serve the common good. Thus to fully appreciate the contribution of Adam Smith it is useful to bear in mind that he approached the problem of optimal resource allocation from the perspective of a moral philosopher. What was interesting from the perspective of moral philosophy was that self-interest could serve the common good, thus self-interest was not detrimental but on the contrary could enable that resources would be allocated in a way that maximised their value for society given the preferences of its inhabitants. He thus noted that the self-interested economic man was a force for good in the market, as his behaviour would imply that prices would reflect the costs and thus enable that resources would be allocated where their value in use were the greatest.

This result was compelling not only as it the resolved the moral dilemma of self-interest versus the common good, but also because it offered a solution to the problem of maximising the value that society could achieve from a given set of resources.

As this was such a powerful result, it is not surprising that the economics profession spent more than 200 years to formalise his intuition. Doing so economists identified all the conditions that needed to be satisfied for Smith’s conclusions to hold and competition policy became a tool for trying to make the world get closer to the assumptions of the model, as it was known that if those were satisfied we would achieve an optimal allocation of resources.

However, the question that was not asked was whether fairness and cooperative behaviour would enable people to realise even more value out of a given set of resources. Adam Smith’s conclusion only applied to the production and exchange of purely private goods, but in the economy there are goods that can be shared or that require cooperation to be realised. In particular at the hunter-gatherer stage and the period of sedation when the human brain was still developing, the production of most goods as well as the ability to survive was based on synergies that required cooperation. In such a situation more value could be realised from limited resources by sharing and cooperating rather than acting selfishly. This can also be observed in packs where dogs bring back prey to share with the dogs that stayed guarding the den with the puppies.

So this focus on selfishness has its origins in a moral philosopher making a clever point
that selfishness need not be as bad as it was held to be.

What does this imply for economics?

I would argue that there is a core of economic principles that does not rely on any behavioural assumptions, and therefore can provide us with insights as to why people (as well as primates) sometimes cooperate and sometimes don’t. This core has to do with the principles of creating, cultivating and realising value.

At the heart of economics is the fact that the value society can derive from its resources depends on how they are used. Economic principles help us understand how we can create, cultivate and realise value from resources. When humans invented the flute some 35000years ago, they created a source of value. Gaining skills to play it, and improving its tone were means of cultivating it, and playing it were means of realising value.

By using and combining resources in a new way we can thus create new sources of value, which enables us to derive more value from them than in their original state. In the case of a flute it generated more value than the stick it was made from. And this is the fundamental economic principle of production, whereby we change matter in an irreversible way that makes it more useful for our purposes.

Now the motivation for creating value does not require any assumption of selfishness. There are many examples of innovators who are totally unselfish and motivated by the joy of innovating.

Thus fundamental economic principles explain why it is possible to create, cultivate and realise more value from resources.

The question is then how this happens in practice.

We can understand the existence of various institutions as means of realising such values, where the firm is an institution for realising value from production, the market one for realising value from exchange, the public sector one for realising value from public goods, and family and friends an institution for realising value from shared resources and so on.

However, neither in production nor in exchange do we need an assumption of selfishness for the value to be realised. The key is the existence of gains from production and/or trade. If these gains are split fairly, there will certainly be an incentive to produce and/or exchange as long as there are some gains to split.

Thus there is a core of economics that provide us with an understanding of why we can realise more value from resources, that is separate from the mechanism of realising them. For some goods it does not matter whether people are selfish or not for the value to be realised, whereas for other goods the value can only be realised if people share and cooperate.

References

Rubinstein (2006) Dilemmas of an Economic Theorist Econometrica 865-883

Why are cultural goods of interest to an economist?

Cultural goods are interesting for several reasons that relate both to the past and the future of the economy.

The fact that these goods existed before humans invented agriculture and were developed to such a level of sophistication long before the industrial revolution and advances in medicine and technology raises many questions. Why did humans put so much energy and resource into developing these goods before they had discovered hygiene and developed technologies for heating their houses more effectively? Indeed it is notable that the French philosopher Descartes froze to death on 11th February 1650 while staying with Queen Christina of Sweden at her caste in Stockholm.

One possibility is that the advancements in technology and medicine were by-products of cultural goods. Hence, it was because humans developed such fine motor skills and trained their brains to such a high level of sophistication by producing cultural goods that stimulated their brains to also address practical problems from a new angle. Leonardo da Vinci was not only a painter, but studied human anatomy in great detail, as well as studying the anatomy of birds which gave him ideas how to construct an aeroplane. When I was twelve I made a model based on his drawings, and I am please to say it did fly to the great excitement of my teacher. Leonardo thus personifies the link between art, medicine and technology.

Hence it is possible that prosperity had aesthetic origins; that it were our aesthetic pursuits that made us a prosperous species.

However cultural goods are not only an antiquity of the past, they also show us the way to a more prosperous future as they evolved precisely because they were an infinite, eternal and sustainable source of value. Hence by studying the properties of cultural goods we may also gain useful insights for the future of the economy, as well as a better understanding of the mechanisms that took us to where we stand at present.

What’s the point of growth?

People sometimes ask me: why do we need growth?

To ask an economist why we need growth is like asking a gardener why they grow flowers. Flowers add value to a garden, and growth in the economy means that more value has been realised through production and exchange. Hence in both cases it is about sources of value, but the mechanisms for realising value differ. In the garden we cultivate a resource to be more valuable to us, but it has not changed its original nature. The same is true when we acquire a skill, such as learning to read, cycle, swim, ski, paint, play an instrument or dance, we cultivate a resource that enables us to derive more value from it.

In the economy, value is realised through production and exchange of goods and services. Production may entail cultivating a resource, such as buying expert advice or going to a botanical garden, but it may also entail exploiting a resource such as cutting down the rain forest. In the case of exploiting the rain forest, which absorb carbon dioxide ( a green house gas) and produce oxygen, the production of ephemeral values is done at the expense of eroding a resource of eternal value, namely the oxygen we need to survive.

Thus when we talk about growth, and whether we want it or not, we need to think about different sources of growth. If the growth is due to cultivating a resource or enhanced resource utilisation, then it is a sustainable source of growth in value. The problems with growth relate to instances where resources are exploited for short term gains.

We also need to be careful with GDP as a measure of growth in value. Whilst Adam Smith is mostly referred to in the context of the invisible hand, another important contribution of Adam Smith was to note that there was a difference between value in use and value in exchange. There are many sources of value that have a high value in use, such as water, but a low value in exchange. Ingvar Ohlsson in his book on National Accounting from 1953 thus issues a word of warning that how GDP should be constructed depended crucially on how it was intended to be used. To analyse trends and effects of public policies, yes, but as an overall goal for society possibly not.

Richard Layard is one of the critics of using GDP as a goal for society. He notes in his book Happiness that despite more than doubling of GDP since the 1950, we are not happier. On the contrary, he comments on rising figures of anxiety, depression and suicide. One contributing factor to this is that whilst growth in GDP indicates more value has been realised from activities that are included in the GDP measure, it does not necessarily mean that people were able to derive more value from available resources. There are sources of value, such as nature and fresh air, hobbies and cultural activities, as well as household production that do not enter GDP.

Thus if growth in GDP merely replaces other sources of value, there may not have been an overall increase in the value that was realised. Thus the fundamental problem of economics which is to create, cultivate and realise value, requires us to identify all sources of value and how they interact. The market mechanism is good for realising value from purely private goods, but for goods with other properties other institutions may be more suitable.

Is art a luxury or a necessity?

Lévy-Garboua and Montmarquette (2003, 211) conclude in a review of the field that ‘It is likely that the demand for arts is price-elastic and art is a luxury good. But this prediction stems more, as yet, from a theoretical conjecture than from well-replicated empirical estimates.’ This conclusion is interesting in light of the ongoing debate about whether art is a luxury or a necessity. So what is then the theoretical basis for believing the origins of art were a luxury rather than a necessity?

The main theory behind art being considered a luxury is based on Maslow’s (1943) theory that human motivation could be understood in the context of satisfying a hierarchy of needs, starting with the physiological, then safety, then love, followed by belonging, then esteem , and finally self-actualization. Once each had been met we would move on to the next. Based on this view art is an activity that people pursue when all these basic needs have been met. However, when reviewing the literature Whaba and Bridwell (1976), found little evidence for the ranking of needs proposed by Maslow, or for the existence of any hierarchy of needs.

Hence, there is little evidence that supports the view that art is a luxury, because it is meeting a less fundamental need in a hierarchy of needs, since such a hierarchy of needs does not exist.

Turning to the literature on the origins of art and aesthetics, I find that the origins of art, and indeed whether there is an art instinct are disputed. Arts antiquity as well as the way in which children spontaneously pick up sticks and start to draw with them, suggests there is an art instinct. However, this has puzzled evolutionary biologists and philosophers alike, since to be an instinct it has to serve a function that either aided survival or reproduction. Explanations have therefore been sought in the various instances where art like behaviour can be found. However, one source of puzzlement is precisely that art does not seem to be specific to any of these particular functions. Thus whilst art like behaviour occur in for example rituals and courting, it may still not have originated there. The philosopher Steve Davies in his book the Artful Species, as well as the neuroscientist Chatterjee in his book the Aesthetic Brain, are therefore neither convinced by the survival argument of Ellen Dissanayake that art plays a function by making special and is therefore used in rituals that aided survival, nor the reproductive argument of Miller that it originated to attract partners.

However, the fact that a phenomena is puzzling on the basis that it appears ‘useless’ from the point of view of survival does not mean that it may not later prove essential for survival. Sleep has puzzled evolutionary biologists as it appears to be an activity that would reduce the likelihood of surviving rather than enhancing it. However, the evidence of the repair function that sleep has for our bodies has made it clear that whilst it in itself may appear useless, it is an indispensable part of a survival package. Indeed we can not live without sleep due to synergies from sleeping and our ability to function when awake.

The question thus becomes is art like sleep, that is a seemingly useless yet indispensable part of a package for survival that is not yet fully understood? Or is it like a chair, that is a luxury good that was invented as a result of technological evolution and economic development following farming?

If art were a luxury good, we would have expected it to have been a by-product of farming just like furniture. However archaeological artefacts show that hunter-gatherers had musical instruments as well as having developed skills to paint and carve images. Due to the fact that many artistic goods, such as dancing, singing and drawing with the stick in the sand will have left no traces other than our natural inclination to pursue these activities, makes it impossible to know for how long humans have pursued them. However, the fact that we can trace art like behaviours to the animal kingdom, such as drawing, aesthetics and playing, suggests that it is more like sleep and thus might be part of a ‘survival package’ that is not yet fully understood.

Indeed the evidence that goes against the existence of a hierarchy of needs suggests that there are synergies across needs, and thus that human needs are working in symbiosis to aid survival. Hence the role that art might have had is a complementary function to other functions for survival, which would make its origins a necessity rather than a luxury.

References:

Maslow, A.H. (1943) A theory of human motivation Psychological Review 50(4) 370-96.

Whaba, M.A. and Bridwell, L.G. (1976) “Maslow reconsidered: A review of research on the need hierarchy theory” Organizational Behaviour and Human Performance 15(2) 212-240.

Lévy-Garboua and Montmarquette (2003) Demand. In Towse, R. (Ed.), A handbook of cultural economics. Cheltenham: Edward Elgar.