By the time you read this, you would have been through the bizarre ritual which constitutes the Union Budget – bizarre not just because in a free market economy like India, the Government’s presentation of its accounts and the modest policy announcements which accompany the accounts should not be an occasion for such hype but bizarre also because hundreds of Economists – who have never held a real job or run a company – prognosticate so enthusiastically on the Budget. As this piece in Aeon explains, this problem isn’t unique to India – the world over Economists who have no idea how the world works whisper nonsense advice into the ears of politicians.
One of us in Marcellus held down a poorly paid job (GBP 1/hour wage) through the last three years of schooling. Then one day, the British Government announced a minimum wage of GBP 4/hour. The op-ed pages of the financial newspapers in the London said that this would lead to widespread unemployment because that is what the supply-demand curves beloved of Neo-Classical Economists suggested. Nothing of that sort happened. Instead, the wages earned by the to-be Marcellus employee quadrupled and that funded a backpacking trip around Europe.
Tom Bergin highlights in this essay that this sort of crazy theoretical nonsense has allowed Neo-Classical Economists to create bad policy decade after decade in most of the world eg. “Up to the 1980s, for example, smoking was seen as driven by cultural factors and the product’s addictive nature – researchers even struggled to get funding for studies that sought to investigate whether price could influence consumption. But at the turn of the millennium, convinced by a raft of economic studies claiming to have established that smokers in developed countries had a clear and fixed ‘price elasticity’ with respect to tobacco, the World Health Organization declared price to be ‘the single most effective way to decrease tobacco use’. And, indeed, since 1980, real tobacco prices have increased as a result of taxes, and people are smoking less.
Yet dig even a little into the data on tobacco taxes, and one is hit by some anomalies. Firstly, economists claim that the short-term price elasticity of demand for tobacco is around 0.4, and in the long term around 1 (meaning that a 1 per cent price drop would cause a 1 per cent rise in demand). If this is accurate, it means price increases drove the vast majority, or all, of the drop in smoking that occurred over the past 40 years. Given that in surveys most people say they quit for health reasons, this seems a stretch.
Second, the fact is that the pace of price increases and smoking rates are not well correlated. For example, the real price of cigarettes in Britain was lower in 1990 than in 1965, but per-capita consumption was 20 per cent lower. What really changed, beginning in the 2000s, was the culture around smoking.
The greatest indictment of the application of neoclassical price theory to smoking is the way those people with the least financial incentive to respond to the price signal appear to have responded most strongly, while those with the strongest incentive were not impelled to react. Today, in affluent neighbourhoods in Britain smoking rates are under 10 per cent, whereas in some poor ones it’s 50 per cent. If neoclassical theory were sound, those numbers would be reversed. Around the world, this trend is replicated. That’s a fundamental breach of neoclassical economic principles.”
However, help is on hand – the Economics profession is turning a corner says Tom Bergin and is beginning to recognise and reward Economists who go into the real world and do ground level research rather than being ivory tower theorists: “In the past two decades, there’s been a turn against ‘blackboard economics’. Some younger economists have made careers out of going out and studying the world as it actually is, and deriving an economics – insights, conclusions and solutions – based on this empirical work. The Massachusetts Institute of Technology and the University of California, Berkeley have been especially prodigious in producing such economists.
Isaiah Andrews, one of these new ‘empiricists’, won the 2021 John Bates Clark Medal – the most distinguished economics prize in the United States. Andrews has worked on the problem of publication bias – whereby research that confirmed prior beliefs could have a better chance of being accepted by academic journals.
Melissa Dell, another of the new ‘empiricists’, won the 2020 Clark Medal for work that highlighted the importance of institutions in the development of economies. Her award signalled a real shift. For almost a century, the economics establishment has downplayed the role of institutions, in part because institutional factors don’t easily fit into the mathematical models that generate precise, scientific-looking results….”
However, there is one problem that most of these empirical (rather than theoretical) Economists face: “In the past 20 years, empirical research has produced many smart and counterintuitive solutions to real economic problems. Esther Duflo, for example, a winner of the 2019 Nobel Prize in economics does what might be considered shoe-leather economics – research that involves observing real people’s behaviour in respect to meeting their material needs. However, the new empirical work in economics suffers from what some economists call the ‘transportation problem’. It might tell you how to encourage the use of efficient stoves in India or improve teaching outcomes in Kenya but the findings don’t establish universal rules about the behaviour of large populations across many markets.
That’s a problem for the economists who enjoy being the go-to experts for policymakers. Universal rules make one universally relevant. But the prevalence of bad economics in public policy isn’t just the fault of economists. Politicians and we, the public, have lapped it up.” So, standby to continue to see the next chapter of fantasy Economics unfold on a TV channel near you.
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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.
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