Economyths - ten ways economics gets it wrong

Renew：Part 15
Author：David Orrell
Update：08-15-2023
Tags：Business Investing
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Chapter List

Chapter 1
Chapter 1, the quest for unchanging laws still drives much of science. Even if the cosmos is in a constant state of flux, the laws that govern it are considered permanent and immutable.2 Mathematics is a way of fixing nature, a kind of photography device to capture the eternal.
Chapter 1, one reason why the economy is so hard to predict is because of emergent properties that defy reductionist a.n.a.lysis. An equally important problem for forecasters is the interplay between positive and negative feedback loops. For every trend, it seems, a counter-trend soon develops; for every driver of a new technology, there is a blocker.
Chapter 7, the sizes of businesses follow a fractal pattern - there are many smaller ones, and just a few big multinationals at the top. Pareto"s 80-20 law was an observation that wealth scales fractally. Indeed, fractals are a kind of signature of complex organic systems operating far from equilibrium, which tend to evolve towards a state known as self-organised criticality.10
Chapter 1, and ill.u.s.trated in Figures 3 and 5, the ability of economic models to predict things like GDP growth or oil prices is not much better than random. Nor have they proved successful at predicting the effects of major policy changes.16 As the economist Alan Kirman noted: "almost no one contests the poor predictive performance of economic theory. The justifications given are many, but the conclusion is not even the subject of debate."17 The problem is not just that the models fail to predict, but that, like the faulty risk models used by banks, they give a false illusion of control. In a 2009 lecture, the economist Paul Krugman stated that much of the past three decades of macroeconomics was "spectacularly useless at best, and positively harmful at worst." Robert Solow observed in 2008 that macroeconomics has been "notable for paying very little rigorous attention to data ... there is nothing in the empirical performance of these models that could come close to overcoming a modest scepticism. And more certainly, there is nothing to justify reliance on them for serious policy a.n.a.lysis."18 Willem Buiter, who was a member of the Bank of England"s Monetary Policy Committee (MPC) from 1997 to 2000, stated on his blog that a training in modern macroeconomics was a "severe handicap" when it came to handling the credit crunch.19 The main effect of the models, in all their neat perfection, has been to desensitise policy-makers to the messy realities and lurking risks of the economy. Another former MPC member, David Blanchflower, wrote that although empirical data were signalling a downturn in the UK economy in mid-2007, the Committee "ignored these data, and as late as August 2008 the majority were arguing that there was not going to be a recession."20 Let alone the longest recession on record. One problem is that the models do not properly account for the role of the financial sector (which in a perfect economy isn"t necessary). The Bank of England"s general equilibrium model, for example, omits banks.21 While Friedman was one of the first to see stagflation as a possibility, not all of his predictions were so prescient. His theory that inflation could be controlled through the money supply alone, for example, turned out to be a huge mistake when it led to extreme inflation in the US and UK.22 The claim that neocla.s.sical economics can be defended on the basis of its ability to make predictions is the kind of extraordinarily counter-intuitive thing that people can say only when they are led by an unshakeable, almost religious belief that they are on the right path. Indeed, Friedman"s mentor at the University of Chicago, Frank Knight, believed that professors should teach economic theories as if they were "a sacred feature of the system" as opposed to mere hypotheses.23 Friedman"s claim of predictive accuracy makes more sense if we see it as throwing down a gauntlet to other theories. Science traditionally evolves when a theory is replaced by one that makes better predictions. If no new and better theory comes along, but there are obviously problems with the existing one, then there is no clear rule on how to proceed. Whatever is in vogue, or has the strongest and most inst.i.tutionalised support, tends to dominate.24 "To say something has failed," says Myron Scholes, "you have to have something to replace it, and so far we don"t have a new paradigm to replace efficient markets."25 So is there really no alternative economic model that can make better predictions than the neocla.s.sical one? The answer is not yet clear, but there is at least a new approach, and at its heart is the very idea of what it means to be human.
Chapter 4 works well for games of dice, less well for financial markets. Another is that it a.s.sumed that market prices correctly reflect correlations. This is related to the efficient market idea that prices are right, and account for all relevant information. The formula also a.s.sumed that markets are stable, so that correlations do not change with time, and that the past is a good guide to the future. In particular, the model was calibrated on US housing data for a period that had never seen a nationwide housing decline. Defaults were rare and random occurrences with a low degree of correlation, and it was never foreseen that the entire market could suffer not just a few random heart attacks, but a ma.s.sive collective coronary.
Chapter 4, one prevailing economic myth is that the economy is inherently stable and at equilibrium - i.e., it is symmetrical in time - and so history doesn"t matter. However, there is the old saying that "the rich get richer," and it certainly seems that to make a lot of money, it helps to have some in the first place.
Chapter 4, complex adaptive systems often tend to evolve towards a critical state - the slope of the sandpile increases until it approaches chaos. The same deregulatory ideology that allowed this instability to develop in the stockmarkets may also be pushing society towards an unstable tipping point. Markets crash, but societies can too.
Chapter 1, our models of the atmosphere aren"t much more reliable than our models of the economy.33 Even so, it is still possible to draw up reasonable targets, and monitor whether the situation is getting better or worse.
Chapter 8, economic growth also often subtracts from environmental quality, which itself is important for happiness. This doesn"t of course mean that growth or progress should stop, only that they should be redefined.
Chapter 7). That doesn"t mean they are appropriate or reasonable. According to one UK survey, 96 per cent of people believed that premier league soccer players are overpaid.19 * We are a little more willing to tolerate high salaries in the case of actors or sports stars because they are entertaining and don"t crash the economy. Important hint: bankers don"t get asked for autographs.
Chapter 3.
Chapter 6.
Chapter 8.
Chapter 10.