16 December 2011

Economics and Thinking

Economists essentially have a sophisticated lack of understanding of economics, especially macroeconomics. I know it sounds ridiculous. But the reason why I tell people they should study economics is not so they’ll know something at the end—because I don’t think we know much—but because we’re good at thinking. Economics teaches you to think things through. What you see a lot of times in economics is disdain for other's lack of thinking. You have to think about the ramifications of policies in the short run, the medium run, and the long run. Economists think they’re good at doing that, but they’re good at doing that in the sense that they can write down a model that will help them think about it—not in terms of empirically knowing what the answers are. And we have gotten so enamored of thinking things through that the fact that we don’t know anything needs to bother us more. So, yes, it’s true that the average guy on the street doesn’t understand economics, and it’s also true that we don’t understand economics. We just have a more sophisticated lack of understanding than the guy on the street.

The value of studying economics is this:  While economics won’t necessarily help you make good decisions, it will help you avoid making certain bad ones.  Stated more clearly, economics provides a foundation for analyzing choices.

In the first place, economics enables you to understand tradeoffs.  Humans are clearly finite beings and the earth is a finite system.  As such, humans can never have everything they want, nor can humans do everything they want.  Recognizing that making tradeoffs is an inevitable component of decision-making is fundamental to economic analysis, and those who study economics are usually in a better position to understand the full implication of this.

In the second place, economics enables you to understand incentives, and the potential long-term consequences that arise therefrom.  This is especially helpful when analyzing system constraints (particularly artificial constraints).  Studying economics enables you to better recognize potential incentive system tweaks (think subsidies, regulation, tax credits, etc.) and plan accordingly.  Once you recognize systemic distortions, you should then ask if these distortions are sustainable, and how you can profit from these distortions while minimizing risk.

Finally, economics enables you to think beyond basic analysis, and weigh policy accordingly.  It is popular in some circles, for example, to say that poverty is caused by a lack of money, and can therefore be solved by throwing money at it.  To shallow thinkers, this makes sense.  But fifty-plus years of history has shown that tossing money at the poor doesn’t solve their problem, and also suggests that systemic poverty is not due to an absence of money but rather to other factors.  Studying economics, then, enables you to see past this rudimentary form of analysis.

In spite of the aforementioned benefits, economics is still incapable of answering all questions correctly.  Some of this is due to the fact that value is subjective, and so all economic analysis can do is provide if-then scenarios.  Some of this is due to the limits of human knowledge, meaning that economic analysis will simply be wrong due to a lack of error.  And some of this is due to the fact that economics has a rather limited application.  These shortcomings, though, don’t change the fact that economic analysis can help you think better and make better (or less short-sighted) decisions.  It doesn’t have all the answers, but it can tell you that some answers are obviously wrong.  And that’s its value.

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