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Wednesday, 21 December 2011

Bah, Humbug … The Value of a Child's Gift

Adulthood

One of the neat things about economics is that it provides different ways of thinking about problems. Take adulthood for instance. This, you might think, is a vague concept which has something to do with children no longer borrowing money from you and not giving it back. Or even leaving home and not returning. An economist, though, sees it differently: adulthood is the moment your child’s spending on Christmas gifts exceeds the value of those they receive. Bah, humbug.

The creep of economics out of its natural domains, finance and resource management, into other areas has a name: economic imperialism. This creep has supposedly been going on for a long time, and has happened so insidiously that it’s been hard to spot. Yet given that we all know that economics is less a science than an invocation of the dark arts of the necromancer this isn’t necessarily a good thing. Maybe, though, this points us in the direction of some overdue reforms of markets, shareholder rights and, perhaps, even capitalism itself.

Berserkers

Economics as it stands has a bit of a credibility problem, on account of the fact that it doesn’t work very well. This is especially true at the points that you want it to most, when markets go completely berserk. It also offers a self-fulfilling prophesy of human behavior – people are expected to behave selfishly and this expectation causes them to do so. Both of these issues are bound up with the uncertain interaction between economics and psychology, and the fact that not only do people not behave the way that economists expect them to, but that they keep changing their behavior as their situations change; we’re reflexive.

Now you would think that if economics isn’t very good at predicting what will happen in finance, which is what it was designed for, people would think twice about applying it to other areas. This isn’t the case, however, and the disciplines, if that’s not too strong a word, of economics are to be found being applied to all sorts of areas that you might not anticipate or relish: religionthe lawthe environmenthappiness and, of course, politics, to name but a few.  Even Christmas gift-giving isn't immune from this attention.

Mission Creep

If you’re wondering why this mission creep has occurred, given the relative failures of economic forecasters, then you wouldn’t be alone. However, economics allows you to measure things and offers a set of tools for making decisions based on the things you’ve measured. This can lead to a rather peculiar situation, which is that if something can’t be measured by economists – stuff like motivations or other inner feelings, for instance – then it can’t be included in the decision making processes and therefore it doesn’t really matter. Bah, humbug.

We’ve seen this before – it’s man with a hammer syndrome. If decision makers only have the disciplines of economics with which to make choices then they’ll often be faced with relatively simple decisions based on ‘hard’ numbers. In general the aim of economic decision making is to maximise the value achieved for the most efficient use of resources, and where the issues are purely economic – say in terms of figuring out how to make a product most efficiently – then this is fine. However, when it comes to more complex situations – such as whether we should extract vital natural resources by destroying ecologically important environments or outlaw abortion or manipulate people into behaving in a way that reduces their cost to the state then the economic arguments are sadly denuded of human value.

Sometimes this limited scope is part of the attraction of such models. After all, if you know that an economic analysis of a given situation is bound to lead to the result you desire then you’re likely to argue that economics should be the main basis for making decisions. Similarly, if you really don’t want to have to make politically difficult choices then simply handing the problem over to economists is a neat way of passing a toxic parcel.

Economic Pantomimes

As part of this pantomime adherents of economic imperialism argue that economics is a science – here’s Edward P. Lazear on the topic:
“Economics is not only a social science, it is a genuine science. Like the physical sciences, economics uses a methodology that produces refutable implications and tests these implications using solid statistical techniques.”
Oh no it doesn’t ….

The foremost proponent of economic imperialism has been Gary Becker, who won a Nobel Prize for his research in 1992 and whose Nobel Prize lecture, The Economic Way of Looking at Life gives a good overview of this approach. These theories are primarily based on rational choice, which essentially is a theory of utility maximisation based on equilibrium – ideas which have both come in for some serious criticism over the ensuing years. Of course, the combination of the failures to predict or help manage the ongoing economic crisis and the development of behavioral finance has meant that the general view that neoclassical economics is an all-encompassing theory has somewhat fallen into disrepute, but economists are now busily applying the new concepts of behavioral finance to areas of limited financial import.

Behavioral Imperialism

Of course, if you can figure out a way of assigning a monetary value to something, however tenuously, then you can apply economics: this is financialization, the trend to reduce everything to a financial instrument, which can then be traded. Behavioral finance, for all its overtures to the dark side, aka psychology, is mostly just an extension of this type of analysis. So, for instance, some commentators see the looming threat of behavioral imperialism in popular economic books like Freakonomics:
"One of the more serious issues discussed ... is the relationship between the legalization of abortion and criminality. Other issues are more trivial and frivolous, such as what sumo wrestlers and school-teachers have  in common, and why drug-dealers still live with their moms".
In The Booming Economics-Is-Fun Genre Jack Vromen argues that this isn't another form of economic imperialism, but is more about junior academics trying to find something notable to publish in a fiendishly competitive market: a problem Bruno Frey describes as the Publication Impossibility Theorem System. But arguably it's also about other disciplines being introduced into economics, which most people would regard as no bad thing if it broadens young economists' horizons.

Reforming Capitalism

Which thought starts to lead us in a strange direction. If we reverse the arguments of economic imperialism by noting that economics isn’t especially good at predicting what it’s designed to do – the economy - then what if the current state of economics is not the best way of organising corporate life? After all, Adam Smith’s original conception of enlightened self-interest as the driver for economic growth didn’t envisage today’s quasi-human super-corporations engaging in value maximisation through de-humanizing incentives. Perhaps we’ve become so used to equating capitalism to the stockmarket that we’ve lost sight of the true nature of market competition.

Two types of reform seem possible, although others will no doubt come to mind. Firstly, we need to look at whether the quoted, immortal, limited liability corporation is the best form of vehicle for modern capitalism. Secondly, we need to consider carefully how we empower actual shareholders to ensure their rights aren't subordinated to those of mangers.

The Value of Nothing

Fortunately there are rebellious stirrings in the ranks of shareholders across the globe, and we’ll be looking at these soon. However, forcing corporations to hold a shareholder vote on their continued existence every few years or so would be a good start, and would nicely concentrate the minds of managers. After all, they wouldn't want their greed to kill the golden goose, would they?

Of course, this won’t stop the kids coming home for Christmas bringing presents with the monetary worth of a soiled napkin. Economists argue about this, but there’s evidence that the old aphorism “it’s the thought that counts” is absolutely true: my valuation of my daughter's wonky home-made Christmas card will be far in excess of the costs of the materials and  labor that went into it. Despite what economics tells us, it isn’t how much you spend that makes you an adult: it’s how much you think.



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