Capitalistic Musings | Page 2

design an experiment to rigorously and validly test theorems and conjectures in economics - or something is very flawed with the intellectual pillars and models of this field.
Neo-classical economics has failed on several fronts simultaneously. This multiple failure led to despair and the re-examination of basic precepts and tenets.
Consider this sample of outstanding issues:
Unlike other economic actors and agents, governments are accorded a special status and receive special treatment in economic theory. Government is alternately cast as a saint, seeking to selflessly maximize social welfare - or as the villain, seeking to perpetuate and increase its power ruthlessly, as per public choice theories.
Both views are caricatures of reality. Governments indeed seek to perpetuate their clout and increase it - but they do so mostly in order to redistribute income and rarely for self-enrichment.
Economics also failed until recently to account for the role of innovation in growth and development. The discipline often ignored the specific nature of knowledge industries (where returns increase rather than diminish and network effects prevail). Thus, current economic thinking is woefully inadequate to deal with information monopolies (such as Microsoft), path dependence, and pervasive externalities.
Classic cost/benefit analyses fail to tackle very long term investment horizons (i.e., periods). Their underlying assumption - the opportunity cost of delayed consumption - fails when applied beyond the investor's useful economic life expectancy. People care less about their grandchildren's future than about their own. This is because predictions concerned with the far future are highly uncertain and investors refuse to base current decisions on fuzzy "what ifs".
This is a problem because many current investments, such as the fight against global warming, are likely to yield results only decades hence. There is no effective method of cost/benefit analysis applicable to such time horizons.
How are consumer choices influenced by advertising and by pricing? No one seems to have a clear answer. Advertising is concerned with the dissemination of information. Yet it is also a signal sent to consumers that a certain product is useful and qualitative and that the advertiser's stability, longevity, and profitability are secure. Advertising communicates a long term commitment to a winning product by a firm with deep pockets. This is why patrons react to the level of visual exposure to advertising - regardless of its content.
Humans may be too multi-dimensional and hyper-complex to be usefully captured by econometric models. These either lack predictive powers or lapse into logical fallacies, such as the "omitted variable bias" or "reverse causality". The former is concerned with important variables unaccounted for - the latter with reciprocal causation, when every cause is also caused by its own effect.
These are symptoms of an all-pervasive malaise. Economists are simply not sure what precisely constitutes their subject matter. Is economics about the construction and testing of models in accordance with certain basic assumptions? Or should it revolve around the mining of data for emerging patterns, rules, and "laws"?
On the one hand, patterns based on limited - or, worse, non-recurrent - sets of data form a questionable foundation for any kind of "science". On the other hand, models based on assumptions are also in doubt because they are bound to be replaced by new models with new, hopefully improved, assumptions.
One way around this apparent quagmire is to put human cognition (i.e., psychology) at the heart of economics. Assuming that being human is an immutable and knowable constant - it should be amenable to scientific treatment. "Prospect theory", "bounded rationality theories", and the study of "hindsight bias" as well as other cognitive deficiencies are the outcomes of this approach.
To qualify as science, economic theory must satisfy the following cumulative conditions:
a. All-inclusiveness (anamnetic) - It must encompass, integrate, and incorporate all the facts known about economic behaviour.
b. Coherence - It must be chronological, structured and causal. It must explain, for instance, why a certain economic policy leads to specific economic outcomes - and why.
c. Consistency - It must be self-consistent. Its sub-"units" cannot contradict one another or go against the grain of the main "theory". It must also be consistent with the observed phenomena, both those related to economics and those pertaining to non-economic human behaviour. It must adequately cope with irrationality and cognitive deficits.
d. Logical compatibility - It must not violate the laws of its internal logic and the rules of logic "out there", in the real world.
e. Insightfulness - It must cast the familiar in a new light, mine patterns and rules from big bodies of data ("data mining"). Its insights must be the inevitable conclusion of the logic, the language, and the evolution of the theory.
f. Aesthetic - Economic theory must be both plausible and "right", beautiful (aesthetic), not cumbersome, not awkward, not discontinuous, smooth, and so on.
g. Parsimony - The theory must employ a minimum number of assumptions and entities to explain the maximum number of observed