Collective Operational Behaviour
Economic thinking remains too insular and introspective. It suffers from the 'not invented here' syndrome. There are so many ideas from other academic disciplines that have the potential to enrich economic thought. One topical example is that economic theories on systemic risk make no mention of ideas from risk management research, or professional practices. One would think the word 'risk' might give economists a clue that they may be attempting to re-invent some wheels? Or worse still they may be driving around in a vehicle with square wheels, wondering why it doesn't move so well. I have recently written a paper covering this subject, for anyone interested titled:
Ilin, Thomas, The Case for Influencing Operational Behaviour in a Macroprudential Approach to Financial Stability (March 15, 2010). Available in PDF format at SSRN: http://ssrn.com/abstract=1572018
My best wishes to 'The Institute for New Economic Thinking'. I hope you help to revitalize this otherwise fascinating academic discipline. My highest regards also to George Soros.
Profit orientation
I'd like to preface this unformed "theory" with the statement that our current economic system was efficient within it's time of creation, but I see some evidence that these times have passed.
I'm more than confused that we still value consumption, i.e. convincing people through advertising to buy things that they wouldn't have wanted otherwise, over anything else, while there's more than enough evidence that our current system is not sustainable, a lately more popularized idea by movies like "StoryOfStuff" or "HOME".
In an era where our technological understanding could be used to "reward" intelligent solutions for poverty, health, happiness, education, culture and sustainability, the modus operandi is still the ever lasting search for maximum profits and the values stated above are only taken into account by charities or social spending of the state.
I have come to the conclusion that we might solve some of these problems by reforming the market economy, but that ultimately the most efficient solution would be to accept that our current focus - production and consumption - doesn't serve the interest of the worlds people and that we have to organize industry in a way that focuses on tangible values - the ones I stated the paragraph above may only serve as an example.
Going beyond mathematics
My point of view depends deeply on the way i have studied economics in french universities. I have been taught that mathematics is the most important tool to understand the way economic variables interact and evolve. I believe it is a necessary tool but the most important one remains experience. But not only the experience accumulated in the business and economic sector. This experience goes beyond these domains.
Economics is a key element among many others in the human ecosystem. An imbalance in finance or economic development could eventually lead to social, ecological or even military problems. Obviously, miltary or political unrest can lead to economic difficulties. Since our economies have reached a high level of international integration, slight problems in the economy can lead to huge strategical issues, which will eventually have stronger and deeper impacts on our businesses.
Economists, especially Kondratiev and Schumpeter, have theorized the business cycles. But there are many other key elements that must be taken into account to have a "more clever" understanding of how the international macroeconomy is shifting. Technology is a key element, but also the scarcity of natural resources and human qualification just to name a few of them.
Bringing specialists from different horizons, with multi-cultural backgrounds, is a first step to build a long term equilibrium, what theorists might call a true sustainable development.
three quotations are sufficient
I will present three quotations. Each one has its own merit.
"As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality " Einstein.
"Can you imagine what physics could be, if electrons had feelings" R. Feynman.
"In Physics you need three laws to explain 99% of the data, in finance you need 99 theories to explain 3% of the data" Andrew Lo, MIT.
S.H
Modern portfolio theory, capital reqts and derivatives
Three theories need to be questioned, as they combine to underpin the New Financial Architecture.
Modern Portfolio Theory says that, through diversification, risk can be reduced without a reduction in return. The old adage is 'not putting all your eggs in one basket'. However, diversification introduces other risks, not least from the institutions that we trust with our eggs.
Secondly, Black-Scholes gave investors confidence to include mathematically priced derivatives in their portfolio. But this theory assumes there is an efficient market: if the market is incomplete no amount of mathematical modelling will discover a price.
Which brings me to the third problem: inconsistent partial reserve banking. If we knew that banks were leveraging monetary supply consistently, such as a 10% capital requirement, this might not be a problem. But prior to the crisis leverage was higher, and now deleveraging is making things worse on the way down.
Combine these three theories and you have a system that blindly invests in debt and derivatives. Yet individuals see investment as a decision that they make about the future, not the way things are today. Academic economics needs to help us invest in a different future, not to re-package the status quo. Anything else would be madness.
Problems with theories in academic economics
1). Government debt is assumed to be risk-free. As we could see from the recent events this assumption could be far from our reality in the future.
2). Market equilibrium is considered to be beneficial and peferable to external regulation. As we could see from the recent events unregulated market equilibrium coud mean disaster for the economy.
3). When economists study historical data they very rarely go further back then the past few decades. I have discovered that going back hundreds and even thousands years of history could bring many different and more complete economic insights. I believe that historical studies of economic heories and policies should be incorporated into the modern theory.
4). It seems to me that economists must recognise that most economic trends originate from demographic trends. Demographic composition of the population and its influence on social and economic system is the most important factor that needs to be studied by the new economic theory. Demographic disbalances, such as aging population, declining fertility rates, growing workforce in emerging markets, declining workforce in developed markets, fall of traditional family values and smaller households, those are the demographic trends that will inevitably shape the economic picture of the future, and they are very different from the past.
5). Market economy relies on rational expectations and rational economic decision making by individuals, while it is well known that most individuals are irrational.
6). Economists are used to see debt from lender`s perspective. And from lender`s perspective debt looks good. The higher the interest rate, the faster his wealth grows. Furthermore, economists like to assume that cashlows from debt instruments are relatively certain. This will not be the reality in the future. When we look at debt from borrower`s perspective it becomes clear why. The borrower is simply unable to repay ever increasing amont of debt due to ever increaing interest. While lenders can charge borrowers in distress higher interest rates to compensate for higher risk , this does not reduce and more likely even increases the risks of default.
7). Free competition is assumed to produce growth and other positive effects, such as reduced cost , or increased differention and quality. While this may be true in the short run, the longer turn effects of free competition could be quite disastrous. Free competition wastes a lot of resources as businessed are forced to enter and exit the markets on a daily basis. More goods are produced then can be consumed in some areas, and the opposite happens in other areas. Coordination can be difficult.
Furthermore job markets where men compete with women and experienced workers compete with young workers can be disfunctional. Where men compete with women for workplace fertility is distroyed and workforce does not reproduce itself. Where experienced workers compete with young experince does not get passed from older generation to the younger. Both phenomena produce shortage of capabale and skilled workforce in the long run and cause economic decline.
Problems with theories in academic economics
At best economic theories may reflect certain behaviour of selected populations in a short term perspective. But since these theories are used in politics the outcome will be negative from a general development perspective of mankind.
More focus on our ability to judge the value of things
In my opinion one of the bigger problems in today's economic theories is that there is to much focus on the supply side of the economy and too little on the demand side. I think especially the capability of people to judge the value of products and services offered to them needs more attention.
My theory is that there is a decrease in peoples ability to judge the value of products and services due to an interaction between the following three factors:
1. The ability of humans to endlessly keep developing new needs whenever more basic needs are fulfilled.
2. The unprecedented growth in wealth in the past decades, first predominantly in the western countries but also in a growing number of other countries like India and China in the more recent past.
3. The lack of experience of humans to fulfill needs of a higher level.
Because of the exponential growth in wealth in the past decades, combined with mankind's ability to keep developing new needs whenever others are fulfilled, a large part (maybe even the major part) of our economy is about fulfilling the higher needs out of Maslow's hierarchy. This might be causing problems in judging the value of products of services because:
- we are unexperienced in fulfilling these needs,
- the degree to which products and services fulfill these needs is more bound to virtual than to physical attributes of these products and services and
- the needs themselves are more volatile because they are highly depending on our level of wealth.
In this situation we might have moved out of the domain in which some of our economic axioms are valid, such as the assumption that in a free market the best price will emerge automatically.
I think it would be worth it to investigate if this is the case. And if it is, we should be thinking about adapting our economic models by inserting parameters for the degree to which we are able to judge the value of the services and products in our economy and then manage the risks associated to that.
Read my short article about this theory on http://members.upc.nl/r.aris/
Kind regards,
Harko Aris
The biggest problem with theories in academic economics
Among the ideas that must be abandoned are cointegration and any notion of 'stationarity' and equilibrium, there is no form of stationarity/equilibrium to be found in any market data when the analysis is performed honestly. If anyone believes that stationarity can be found, I offer a $500 bet, and time averages are not allowed: time averages do not and cannot converge to ensemble averages for nonstationary processes.
Can we really expect a
Can we really expect a mathematical model to apply to something as random as human behaviour? I woudn't be able to find one to predict my own (often haphazard) behaviour, far less one that encompasses that of my neighbours or society or "the market" as a whole. Yet this is what academic theories and modelling appear to attempt to do, leading often to the creation of a false sense of security.
Human behaviour ultimately can not be predicted or made a hard science of.
Physics and mathematics work well (within limits) when applied to inanimate objects governed by the laws of nature (e.g. motion of the planets). Can the "free will" aspect of human behaviour be quantified/qualified?
- 1 of 8
- ››
