WHY ECONOMICS MATTERS

A Case for Informed Citizenship.

Economics is important. Why? Because political participation test our economic knowledge and the accuracy of our economic beliefs. Economic beliefs matter because they shape policy and social welfare. Even if you are politically apathetic, your beliefs can legitimize the actions of policymakers and other political actors. If you think that trade with other countries is a zero-sum game - where importers lose in the economic game - then your (incorrect) view of trade can be appropriated as a popular will by the government to legitimize destructive protectionist policies like bans and high tariffs. This is not to say we are incapable of making sound economic decisions. Its just that we pay attention more to our decisions themselves than how we think about them.

INTUITIONS AND INFERENCES

Even before the internet and social media, our ancestors have been swimming in an ocean of information. Our senses are receptors of information from the environment and our survival depended on how we learn from the information we have. Processing these information takes a lot of cognitive power. Our brain consume the most energy of all our organs. To solve this problem, biology wired us with automatic inference systems that helps us make decisions. These cognitive inference systems evolved with our physical development, and some morphed into emotions. Our flight or fight response, or our perception of reality and danger are examples of cognitive shortcuts.

Anthropologist Pascal Boyer observed that we have intuitive inferences about human interactions the same way we do about our environment. We evolved to live in small groups and are highly social. Navigating human sociality can be as challenging as surviving a harsh winter or the deep forest of the Serengeti. Therefore we evolved strong intuitive inferences to interact with other humans seamlessly. We have intuitive inferences about economic exchanges with other humans. We also have strong moral intuitions about those exchanges. We inferred that exchanges should be fair and equitable. We become deeply displeased when exchanges are unfair and unequal. We inferred the need to get justice in such situations. Boyer, along with Michael Petersen, observed that these intuitive inferences about exchanges with other humans is the source of our “folk economic beliefs”(FEBs).

WHY SO KNOTTY ?

Humans no longer live in small tribal bands. We have built cities and invented new mind-blowing technologies. Population has grown to billions of people. With these fundamental changes, come challenges to our old mechanism of exchanges. We had to invent new governance modes like government and business firms. We coped with these changes (and also made them happen!) through cultural evolution - but our intuitive inferences are still how we navigate the social world. New civilizations, institutions and technologies are built with new knowledge. The growth in the stock of knowledge birthed the need for specialization. Proficiency in specialized knowledge require a lot more cognitive effort than our intuitive inferences. This is why we misunderstand economics. Our understanding of economics still rely largely on our folkways, and we lack the incentive to acquire the necessary domain knowledge. Opinions about economic matters are driven by broader social, political and personal attitudes and beliefs, and not in-depth understanding of economic systems.

HOW WE MISUNDERSTAND ECONOMICS

Economics often gets a bad rap as a dismal science. Critics have seized every available means to blame economists for many undesirable social outcomes. This is incorrect and most unfortunate; if only they can be more open-minded. Economics is a powerful tool for understanding the world. Like other domains of specialized knowledge, it has many flaws. And economists can be poor popularizers of core economic principles and concepts. But these concerns do not justify the deep distrust we have for economics. We are firmly under the influence of our FEBs - but we also err in systematic ways and have many biases. Many people support a broadly enforced minimum wage law. But if an economist points out the possible disemployment effects of minimum wages, they will surely get some dirty looks. Such skepticism can go missing when a psychologist claims that doing the “Wonder woman” pose can make you do well in a job interview. Yet economics is methodologically more reliable than social psychology.

In their book, “How We Misunderstand Economics and Why It Matters”, David Leiser and Yhonathan Shemesh carefully documents some of the sources of our systematic errors in thinking about economic concepts. I will briefly review a few of them.

1. CAUSALITY IS HARD - Economics is a social science. And as economist Arnold Kling astutely observed that “there are many factors that affect human behavior and human interaction”. The inability to isolate singular causes of events makes social science less precise. Statistician Andrew Gelman stated that there are almost “no true zeroes” in social science. This means there is no absolute starting point to observe or measure human behaviour. We are not blank slates. Our mind is perpetually rich with thoughts and motivations all the time. No theory of human behaviour is definitely supreme to an equally plausible (or provable) one.

Take an economic phenomenon like productivity. It is recognized as a significant driver of growth and prosperity both in companies and the economy. A recent World Bank report identified the important causes of productivity as innovation, education, market efficiency, infrastructure and institutions. As if this is not complex enough, a survey article by economists Chad Syverson reviewed most of the economic literature on productivity and identified these causes of productivity - managerial talent, quality of labour and capital inputs, Information Technology, Research & Design, learning by doing, product innovation, firm structure and decisions, spillover effects, competition, deregulation and proper regulation, flexible input market, trade competition. I won’t blame you if you have given up at this point. Not all economic phenomena show this much causal density, but the pattern generally holds. Multiple causation is barrier to our understanding of economics - especially with growing complexity of modern life.

2. DIRECT AND INDIRECT EFFECTS - Estimating causality can very be difficult. But when we do it, we are only able to fathom the direct links between actions and outcomes. We do not think of the indirect effects and interactions involved. Support for minimum wage law are examined through the lens of directly raising workers’ earnings and living standards. Thinking that may lead to employers refusing to hire or sacking workers due to rising wage costs is difficult. There is no obvious direct link between the two. Workers provide valuable labour for companies; who then sell goods and services for profits. So why won’t they pay their workers better? This is where our thinking stops. Policymakers may also think that banning foreign milk will directly boost local production of milk. Or that closing the land borders to rice importation is the key to stopping rice smuggling. The logic is the same. Take a direct action, expect a proportionate direct result from your action. Thinking stops and we gets confused and annoyed when the results are distorted. It is difficult to fathom that bans make smuggling very profitable, and that results in a surge in smuggling. This is not what was intended.

3. ECONOMIC VS MORAL REASONING - Economics cannot escape normative concerns. It is the primary means we use to evaluate our social welfare. Since we are born equipped with an intuitive moral system, then it is understandable for us to juxtapose economic and moral thinking. The problem is that we are often incorrect in our analyses. I once got into an ugly argument with a social media “influencer” (ironically an economic consultant). The subject of our rancour was whether a popular fast-food chain is greedy and evil for pricing higher at its outlet located at a popular shopping mall than another of its outlets outside the mall. For the record I maintained this was reasonable practice but my interlocutor disagreed. I do not think this makes me smarter than this person. A few years before our encounter, I could see myself making similar arguments. But I learnt through multiple sources that restaurants and fast-food chains are as much in the real estate business as the food business. Our moral intuitions are very useful but psychologist Jonathan Haidt warns that they can “bind and blind” us. They can form a thought matrix that pushes us towards an ignorant loyalty to a misguided cause than towards the truth.

WHAT CAN BE DONE

Reading this post will not suddenly nudge you to consider locking yourself in a room with an economics textbook over a weekend. But this is not a required remedy, so do not lose hope. The underlying lesson here is not that humans are stupid. But that we seldom realize or accept the limits of our knowledge. You need to accept that the world is complex and shirk all assumptions of simplicity. Economics is hard, and we need to approach economic thinking with humility and careful attention. This does not mean a blind deference to experts. In many ways, some economists are gravely prone to the same errors we have identified above.

A useful first step is to always seek to understand beyond our gut reactions and intuitive responses. You need to deliberately seek and court sources of knowledge that disagrees with you. This does not mean you will always change your mind, but engaging with other arguments can help you see the shortcomings of your views. Knowledge is not a solitary venture. But you should be suspicious of groups or individuals who place collective identity and loyalty over truth. A true community of knowledge revels in improvement and learning, not conflict. Knowledge is incremental. Learn something new everyday. You should treat knowledge like a skill and find deficient areas that needs improvement. Economics is not all there is to know about the world, but it is a useful tool in understanding the modern world.

Further Readings

Specialization and Trade - A re-introduction to Economics by Arnold Kling

Undercover Economist by Tim Harford

Minds Make Societies - Pascal Boyer

How to Think - Alan Jacobs