Economically Proper: Economic Thinking to Move Us Forward

By Dr. Huynh Bao Tan

The way forward for economic thinking is to view and use economics as a data-driven tool to ameliorate the collective economic outcomes for everyone involved in an economy. Economics as a tool has a tremendous power to improve the lives of millions; and by and large, it has helped us achieve that over the past couple of centuries. But as we are facing pressing global threats on many fronts, economics cannot continue in the way it is practiced now, constrained and distorted by constant political and ideological influences and special interests. It is time to put economics back to where it belongs: a rigorous science that respects data, results, and evidence, not a misappropriated tool to serve political and ideological agendas and the interests of the elite few.

• Language: English
• Publisher: Partridge Publishing Singapore
• Release date: Jul 10, 2018
• ISBN: 9781543746761

Dr. Huynh Bao Tan

Dr. Pete Huynh adds his unique voice to economic thinking and debates through his experience in economic research and teaching at the undergraduate and graduate levels. He promotes a moderate, impartial view of economics that is based on data, evidence, and experience, and is geared towards the public good.

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Copyright © 2018 by Dr. Huynh Bao Tan.

Library of Congress Control Number:   2018950867

ISBN:              Hardcover              978-1-5437-4674-7

                        Softcover                 978-1-5437-4675-4

                        eBook                      978-1-5437-4676-1

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CONTENTS

What Is Wrong with Economics?.

The Trouble with Economics

The Twin Pillars of Economics: Trade-Offs and Rationality

Beware the Fallacy of Composition

Chapter 1   Long-Run Economic Well-Being: Supply

Major History Lessons

Creating a Market

Economic Growth in Theory

Supply-Side Economics and Classical Economics

Lessons for Long-Run Economic Well-Being

Chapter 2   Wealth Redistribution

Wealth Redistribution and Market Correction

Wealth Redistribution and Inequality

Technology and Wealth Redistribution

International Trade and Wealth Redistribution

Wealth Redistribution and Growth: A Trade-Off?

Moral Hazards

Optimal Size of Government

More than Just Profit Maximisation: Towards a More Social Form of Economics

Ways Forward: Universal Basic Income

Chapter 3   Creation of Wealth

What Is Wealth Creation?

Wealth that Is Not Wealth

Money and the Financial Sector

Regulations of the Financial Sector

Returning to the Manufacturing Roots

Chapter 4   Concentration of Power

Free Markets Double-Talk

With Great Power, Comes No Responsibility?

Modern Life and Large Corporations

Power Concentration and Leadership

Chapter 5   Demand-Side Management

Economic Management of Bubbles

The Imperfections of Economic Measurements and Policies

Separating Economic Decisions from Politics

Economic Practice with Intellectual Honesty and Integrity

The Way Forward

Chapter 6   The Peculiarity of Economic Analysis

Chapter 7   Competition versus Cooperation and Global Coordination

International Framework of Cooperation

We Make Economics, or Does It Make Us?

Conclusion

References

To my long-suffering wife, Ivy.

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WHAT IS WRONG WITH ECONOMICS?

The First Fundamental Theorem of Economics

For every economist, there exists an equal and opposite economist.

The Second Fundamental Theorem of Economics

They are both wrong.¹

The joke is one that I tell quite often in class. It has a nice setup, in that it gets my students’ attention. They would get quite apprehensive about these mysterious fundamental theorems that they haven’t heard before. If they were so fundamental, why hadn’t they learnt them? And then the punchline comes, and there is a release of tension as well as amusement. (I sometimes spoil the joke by making the setup a bit too serious before delivering the punchline. Perhaps some students can’t quite imagine that we economists could make fun of ourselves.)

The joke exaggerates, of course, but it does capture quite nicely the predicament of the economics profession. One of the biggest challenges in teaching undergraduate and graduate economics is having an adequate and satisfactory answer to my students’ questions along the line of why, if so much of economics doesn’t seem to work, we continue to study it and put our faith in it. This question usually follows discussions about the shortcomings of economic models and the failures of economic policies to foresee economic crises as well as deal with long-standing economic issues.

It is easy to get defensive and dismiss this question as naïve or simplistic, or to greet it with a shrug, but for lecturers who want to equip students with practical economic knowledge so that they can make a good career out of it and apply it to solve real-world problems, the question must be addressed honestly because there is a lot of confusion and perplexity regarding this matter.

The economics profession is currently enduring a bad name, and deservedly so, in all honesty. We can see this from the many crises that we failed to predict and properly deal with, let alone prevent, to the continuing malaise of stagnant wage growth for the low-income and middle-income classes, the shrinking middle class in many countries, and widening inequality. We have also failed to use economics to ensure that people everywhere in the world have enough to eat, even though we as a whole are producing quite enough food for the entire human race.

It also doesn’t help that the daily airwaves are filled with vague, less-than-helpful pronouncements, confusing business and finance with economics. Common economic errors and fallacies are spread daily on television. Economics is used and discussed in a general, speculative kind of way, almost entirely lacking in intellectual and theoretical seriousness and often leaving viewers none the wiser. One of the most often heard phrases is ‘but looking ahead, there is still a lot of uncertainty in the markets,’ at which the economic mind boggles, because there has never been a time when there isn’t uncertainty in markets.

This points to the strange state of economics as a serious field of study. The field is indeed populated with true intellectual giants, pioneers in groundbreaking theories and earnest seekers of economic truths. But it is popularised and practiced in a way that is perplexing and practically unseen in any other sciences. Where are all the true experts in the field, and what have they been doing? Is not economics the profession to address and correct current burning economic and related social issues? These are the questions that the people on the street ask, if they bother to ask at all. It is more probable that economics to them is an esoteric field of study with no practical use and a bleak job prospect.² We can say, ‘But hey, no one really knows or cares what a particle physicist does either’ (my apologies to particle physicists; no offense intended). But then, we don’t see them daily on television proclaiming all sorts of wisdom. And when they are on TV, they speak with true, illuminating authority, so that we can learn what they have truly given us in terms of their labour in the field.

And so, the question why we need to continue to teach and study economics is a tough one question to answer. If a practical value must be put on learning economics, then what is the use of learning it if so much of it doesn’t seem, well, practical?

This is the fault of the economics profession, from the way it is taught to the way it is practice, to the way it is popularised. If not many people know what particle physics is about, that is because the nature of the science demands it. No one pretends to know anything about it, because we know that it is best left to the true experts. Not many really know what economics is, either, but many seem to have some distorted view and understanding of it.

Economics is at the foundation of much of modern civilisation. It is not about buying and selling, as some would think, nor is it about numbers. Economics seeks to explain the forces behind the buying and the selling and the numbers. Economics is not interested so much in the fact that the numbers go up and down as why they go up and down. It is an interesting and complex discipline, giving us great insights into a wide range of behaviours and decision-making processes.

Microeconomics studies what constitutes optimal decision-making at the individual level, lending itself very well to the arts of management. The area of game theory is behind the design of auctions and other forms of bidding. Game theory also helps us understand and limit the negative consequences of arms races and other forms of uncooperative games. For years, mechanical design has been providing guidance to various issues, from corporate compensation structure to designing healthcare and insurance policies. Industrial organisation allows us to understand the competitive behaviours of firms, while trade provides us with the knowledge that trade is essentially a good thing and the foundation upon which to build win-win trade collaboration.

With microeconomics, we understand why, even though the possession of a degree doesn’t always mean good work performance, we continue to assess and select people based on this criterion (it is a signalling problem). We also understand why insurance premiums are high and why we generally can’t fetch a good price for our used cars (adverse selection). With these insights, we can use economics to devise mechanisms to limit the extent and consequences of these problems.

At the macro level, economics gives us a highly accurate picture of how the economy functions: the flow of goods, capital and money, economic fluctuations. It tells us how countries grow over time and why they differ in income and living standards. It tells us why we need money and why there is inflation. It teaches us that pegging the exchange rate of one’s own currency is highly difficult if one is also committed to an open capital market. It paves the way for international economic cooperation and established the raison d’être of the IMF and the World Bank.

Macroeconomics has also provided guidance on policies that are good for economic growth and economic stabilisation. These policies have to a certain extent provided the tremendous growth that we have seen in the world economy over the past fifty years. They allow the miracle of the East Asian tigers and China to happen.

Almost all of our civilisation’s progress is due to scientific discovery and technological progress, but the other engine powering our advances is economics. Technologies are commercialised because the benefits we derive from them far exceed the costs. Economic decisions often turn the frontier of science into everyday applications. The race to be the first to be credited with a discovery or invention is usually followed by the race to get it first into markets. The basic beauty of economics is that, even though most of these decisions are made essentially with self-interest (profits, recognition, and so on), through a market-based mechanism, they provide steady, sometimes spectacular, benefits (if not equally distributed) to the wider society.

Thus, the answer to the question must be tempered with qualifications. Economics underlines most of our activities and decisions; it colours our thinking, whether we are aware of it or not. it is thus an immensely important subject, whether we would like to study it or not. To study and understand it imperfectly, with the hope that the body of knowledge will be gradually, bit by bit, perfected, is still better than not knowing it at all. Economics is a beast that is better tamed to serve us than let to run wild. It is not well domesticated yet, so it may occasionally turn and bite us, but this is nothing compared to the scenario in which it is a completely wild animal. And in any case, the mystery posed by economics is too great for the curious human mind to resist trying to decipher its secrets.

The second qualification is that economics is sometimes blamed unfairly, because the answers that we ask of it cannot be provided by its insights. It is asked to provide solutions to issues that are essentially outside its domain. To keep it both simple and general: To resolve certain issues, we as a collective have to agree on what the desirable social outcomes are first and then ask economics to provide us with the mechanisms to reach these outcomes, not the other way around. But we often ask economics to tell us what social outcomes to have, which it of course cannot, and are surprised at its failures. This will be touched upon throughout the book.

Thus, along this line, it is worth keeping in mind that sometimes, it is we who fail economics, not the other way around. Economics is a tool, just as anything else, and it is often a two-edged sword. Just as a knife can be used for either good or bad, so can economics. Economics can, and should, be used to pursue worthy social purposes, not as a means to hoard wealth and power. Good economic policies can be pursued that put the welfare of society as the top priority; bad ones will continue to depress wages and harm the environment. To a large degree, good economic policies abound, but evidence from around the world shows that it is still misused.

The third qualification is that it isn’t that economics doesn’t work; it just doesn’t work as well as we’d like it to. Economics is a relatively young discipline, and younger still if we count the time since it has become more grounded in mathematics. Our current knowledge of it is still nothing much compared to the body of knowledge of the other sciences. At one end, there is still so much that we are still uncertain about, while at the other end, the profession seems awfully certain and cocksure about certain policy outcomes (‘This tax cut will bring in jobs and growth’ and the like) when it has no right to be.

The economy is, essentially, just very hard to manage, even without the help of bumbling bureaucratic incompetence. It is built upon a number of pillars, many of which are solid. But at least two of them are, shall we say, made of sand: money (through the financial system) and expectations. Their sandlike nature is inherent, even before any wilful attempts on our parts to manipulate them. They are simply too volatile. A press of a button is all it takes to withdraw all money out of a region and plunge it into economic turmoil. Likewise, expectations can shift seemingly overnight, causing a hitherto stable situation to descend into chaos. The pound sterling crisis in 1993 is an example of this. The pound was stable, until markets decided that it was not, and then it went off the cliff. Managing an economy well requires not just a thorough and in-depth knowledge of economic conditions but also quick policy reaction, something that is all-too-often very hard to achieve, especially in a fractious political environment.

Let’s take a more detailed look at the problems in economics.

The Trouble with Economics

The first problem runs at the core of economics itself as a science. Even though economics has been establishing itself as a rigorous science, with increasingly indispensable mathematical tools used in all sorts of economic modelling, it is quite unlike other disciplines, especially the physical sciences. It occupies this strange place of straddling the boundary between the humanities and the physical sciences. It suffers from a split of personality, so to speak.

Its many so-called laws are nothing such, at least when compared to the mathematical and physical laws that govern the actual world of nature. It is ultimately a study of human behaviours, and where human behaviours are concerned, they are influenced by moods, sentiments, lack of knowledge, and irrationality. So when we formulate and use economic laws, the implicit understanding and acceptance is that these laws hold to a good general degree, and the results we derive from them, while giving us great economic insights, cannot be taken as absolute truth.

At the same time, economics has been for a long time firmly established on the foundation of rational decision-making, the principle that economic agents make decisions to maximise their own interests and hence welfare. This principle acts as the guiding light for all theories in economics, and while it works well in a vast variety of scenarios, it doesn’t capture all aspects of what make economics work. For instance, economics continues to struggle to model and explain behaviours that lead to economic bubbles and crashes, and how to deal with them. Exploring instances of imperfect rationality, even irrationality, is right at the frontiers of economic research.

In fact, it has been argued (in a recent paper by the economist Gregory Mankiw) that the theoretical and mathematical focus of economics has been to such an extent that it takes economics further and further away from the realm of applicability. Sometimes, economists seem lost in the making and interpretation of mathematical economic models—beautiful, complex, and rigorous—but more often than not carrying oversimplified or unjustified assumptions.

We can see this point more clearly with a specific example. For instance, a number of theoretical results have established that there are few benefits of using policies to stabilise fluctuations in an economy’s output, or gross domestic product (GDP). A downturn is often followed and offset by an upturn, and so there is no need for any intervention in terms of public policy. The direct interpretation coming from these results is that major recessions such as the Great Recession of 2008 need no interventions; they will be followed by great economic booms, which will compensate for the losses during these recessions.

Admittedly, results like these make for great intellectual and theoretical curiosities. But they are just that, because putting these against actual experiences immediately tells us that there is something not quite right with applying this kind of theoretical understanding to practical economic governing. A number of objections can be raised here.

First, results such as these ignore the microeconomic side of things, namely the actual experiences of people going through recessions and booms. Who would willingly accept to have their job cut, enduring real and painful losses in terms of income and healthcare, in the knowledge that the economy will be booming in the future? Even if they may unwillingly accept this outcome, they might be constrained by the more immediate needs that their circumstances impose upon them. Certain economic losses may be permanent or irreversible, so that the gains restored later are in no way commensurate to the losses suffered earlier.

Second, they ignore the distributional effects. Who can be sure that exactly the people who have suffered the most through a recession will all be rightfully compensated during the next boom? (If anyone proposes that the government can help, we are right back at policy intervention.) This is especially true if the recession and the boom that follows have different causes and origins, so that people from different sectors of the economy are involved.

Third, as the Nobel laureate Joseph Stiglitz mentioned in this book, The Great Divide, it has been the case, and increasingly so, that the economic gains are ‘privatised’ while the losses are ‘socialised.’ This will be discussed in more details in chapter 4, but what it means is that economic gains are accrued to individuals, usually the most wealthy and powerful, based on the principles of free markets and private ownership, but economic losses are borne collectively, often disproportionately so by the lower income groups, through reduced social spending and tax increases. So the boom that follows a recession will almost certainly massively redistribute income from the bottom of the income ladder to the top. There is no evening-out for the people at the lower income ladder in the long run, if the economy is left to fluctuate (sometimes wildly) on its own. (The technical concept for this is that the economy is path- or history-dependent. It matters not just where the economy is going, but also how it gets there.)

There are other theoretical results like that in economics. And they are necessarily theoretical, because if something funny is going on with actual economic data, we have no choice but