Economics is a fascinating subject. The so called dismal science1 has over the years come up with several models and theories that explain “the economy”. At the base of this magnificent edifice, however, lie some shaky assumptions.
One of the most widely criticized assumption is also the one that brings elegant simplicity to the subject. The assumption is that we are rational maximisers. That is to say for each one of us maximizes something which economics usually only vaguely labels as “utility”. In theory, utility could be anything, even subjective. Indeed, its roots probably lies in the idea that utility is a proxy for happiness. This is evidenced by the quote “the greatest happiness for the greatest number of people” which is the heart of utilitarianism.2
The problem with subjectivity
As with all things subjective, happiness is a very hard thing to measure. People’s ratings of their own happiness, for example, can be significantly influenced by asking them priming questions. In one study3 researchers affected self-assessment of subjects’ happiness by asking them questions about their dating lives before they rated their own happiness.
Even if it were easy to measure, given the proliferation of self help books and gurus, I doubt if we are really happiness maximizers; but I digress.
The homo economicus
Given the difficulty of dealing with subjective definitions of “utility”, most of economics assumes utility to be money or its equivalents. Herein lies the problem – most of us are NOT rational money-maximizers! Paul Krugman in his recent essay titled “How Did Economists Get It So Wrong?”4 called it “mistaking beauty for truth”. While the assumption makes for beautiful models, it is simply not true.
Study after study has shown that we value the risk of small losses higher than equivalent gains.5 We value things we own higher than we would have if we didn’t own them.6 We feel the need to reciprocate any favors bestowed upon us.7 Even with games like the ultimatum game, people have been shown to incur a cost to themselves to punish others who they think are unjust.8
These and more studies on human behavior are littered with evidence for our irrationality. Of course, you won’t find a lot of people (economists excluded) claiming that we are perfectly rational. 9 This criticism has lead to a caricature of human beings as seen by economists into a separate species called homo economicus.10
Economic growth as panacea
These behavioral problems with economics are well known. In fact there are fields of study called behavioral economics and behavioral finance.11 Why, then, am I waxing about it? Well, for one, all of us seem to have accepted economic indicators such as GDP and GDP growth rate as the prime measures of well-being. Policy is decided to promote economic growth, we target growth numbers; indeed, we view economic growth as an almost-panacea to all our problems. Don’t get me wrong, I am neither a Luddite nor a communist. However, I do see some problems with this worldview.
Lifting masses out of poverty
We often hear this phrase, that economic growth lifts X million people out of poverty. I am not sure if systematic evidence exists for this. In a very well written article about the ills of pure free market capitalism called “Beyond Selfishness”,12 Henry Mintzberg, Robert Simons and Kunal Basu argue that growth has actually increased the income disparity in the US. They argue that, in real terms, the lowest class may actually be worse off after growth and that the richest are disproportionately better off. In other words, a gross 8% GDP growth may conceal 125% growth to the ultra-rich and -2% “growth” to the ultra poor.
Of course, some disparity is to be expected. In economics, most of this would be attributed to “productivity”.13 The argument is probably correct. But the reasoning stops abruptly at productivity. What causes such drastic differences in productivity? Some of it may be attributable to industriousness and inherent abilities of people, but a lot would probably be attributable to opportunity.
Another problem with economic growth is that, while a homo economics would be happy if his assets grew in absolute terms, a homo sapien would only be happy if he is better than the homo sapien sitting on the next tree branch!14 Again, don’t get me wrong, I am not saying absolute growth is not good. I am merely suggesting that, possibly, rat race, lack of leisure time etc., that are hallmarks of our time are probably a result of our mindless pursuit of higher productivity.
But what about happiness?
Our beautiful neighbor up north, Bhutan, has come up with a nice concept christened Gross national happiness. King Jigme Singye Wangchuck , who abdicated his throne to create democracy in Bhutan came up with this concept. Although this suffers from the problem of being vague, it seems like a neat start.15
The question remains, while the imaginary homo economicus may be ecstatic at our unwavering focus on growth, what about us, ordinary mortals?
- Carlyle and the Racist Origins of the Idea that Economics was “the Dismal Science”, Gavin Kennedy, Professor Emeritus, Heriot-Watt University [↩]
- Jeremy Bentham – Biography [↩]
- Priming and communication: Social determinants of information use in judgments of life satisfaction, Dr. Fritz Strack, Leonard L. Martin, Norbert Schwarz, European Journal of Social Psychology, Volume 18 Issue 5, Pages 429 – 442 [↩]
- How Did Economists Get It So Wrong?, Paul Krugman, The New York Times, Magazine, September 2, 2009 [↩]
- Prospect Theory: An analysis of decision under risk, By Daniel Kahneman and Amos Tversky, Econometrica, Volume 47, March 1979, Number 2. (Specifically, see Figure 3: A hypothetical value function, pp 279) [↩]
- The so called endowment effect [↩]
- Market versus social norms as explored in The cost of social norms, chapter 4, Predictably Irrational by Dan Ariely [↩]
- What is the Ultimatum Game? September 24, 2003, Neuroeconomics, Center for the Study of Neuroeconomics at George Mason University [↩]
- Check out the size of the list of cognitive biases on Wikipedia! [↩]
- From Homo Economicus to Homo Sapiens, Richard H. Thaler, Journal of Economic Perspectives—Volume 14, Number 1—Winter 2000—Pages 133–141 [↩]
- The Marketplace of Perceptions, Behavioral economics explains why we procrastinate, buy, borrow, and grab chocolate on the spur of the moment. By Craig Lambert, Harvard Magazine March-April 2006. [↩]
- Beyond Selfishness, By Henry Mintzberg, Robert Simons and Kunal Basu, MIT Sloan Management Review, October 15, 2002 [↩]
- Wikipedia has a decent article on productivity. [↩]
- Will raising the incomes of all increase the happiness of all?, by Richard A. Easterlin, Journal of Economic Behavior & Organization,Volume 27, Issue 1, June 1995, Pages 35-47 [↩]
- For more information go to http://www.grossnationalhappiness.com/ [↩]