Sunday, March 22, 2009

What Kind Of Economist Am I?

WY asks what school of economic thought I support. The answer in a nutshell is...whatever works.

Here's the story - strike that, here's my summary of the history of economic thought:

The classical school - Adam Smith, David Ricardo, Hume, Bentham, Marx, Marshall and many others - really set the foundations of economic thought. They gave rise to many competing ideologies which didn't necessarily agreed with each other. For instance libertarianism and the Austrian school take freedom as the sole guiding principle of economic organisation, while Marx suggests the diametric opposite. Both are considered on the lunatic fringe in modern economics.

The classical school eventually gave way to the neo-classical school, which attempted to describe economics within a mathematical framework. The Great Depression and the rise of the Keynesian revolution derailed this movement momentarily, but it revived and assimilated Keynesian thought under the neo-classical synthesis starting with John Hicks (the ever popular and still relevant IS-LM model).

The 1970s brought stagflation and the breakdown of heretofore established macro-relationships, bringing about a resurgence of classical ideas, with an emphasis on micro-foundations for macro analysis - the new classical school.

The 1960s-70s also coincided with the rise of monetarism, which combined some of the ideas of the Austrian school with the neo-classical synthesis. Also known as the Chicago School from its identification with Milton Friedman, monetarism reduced economic policy management to essentially one tool: "2% money supply growth" (see Goodhart's law to see why this failed).

The new keynesian school essentially takes a cue from the new classical school by applying micro-foundations to keynesian macro analysis. These two competing schools of thought comprise mainstream economics today.

Then there is the heterodox school. Well not really a school per se, but rather a loose term covering economists who don't fall under a convenient label. These include people like Joseph Schumpeter and JK Galbraith.

The reason why you see economists disagree in the current crisis on seemingly basic questions like the effectiveness of fiscal stimulus or its structure, or whether it will work at all, goes back to their basic ideologies:

1. New classicals believe in complete markets and rational agents, and that government is less efficient in allocating resources. As such fiscal stimulus is less likely to be effective, and if stimulus has to be done, tax cuts are preferred.

2. New keynesians believe that markets can fail and prices are sticky, in which case there is a strong case for government to step in. Inefficient allocation of resources is better than no use of resources at all.

3. Monetarists don't believe fiscal stimulus works. All we need is 2% money supply growth.

4. Austrians and libertarians don't believe in government. All we need to do is go back to the gold standard and abolish all the central banks.

5. Marxists believe capitalism is doomed to fail. All we need is...never mind.

Where do I stand in this milieu? I admit I began my career a monetarist, with some leanings toward libertarianism. Age and (hopefully) some wisdom now puts me somewhat left of centre - markets do fail, frequently in fact. I also have some sympathy for some of Galbraith's and Schumpeter's ideas, which while often in conflict, do a better job of describing the real world then either mainstream school. It's hard to accept the efficiency of price signals, when competitors are essentially oligopolistic.

Having said that, I think my approach to economics is purely pragmatic. Some ideas work at some times, but not at others. It is a mistake to take a one-size-fits-all approach, especially when contemplating a developing country with immature markets and institutions. Just as important, I lean on empirical evidence rather than relying purely on the dictates of theory.

Theory only provides a framework for thinking, and it pays to listen a little to all the schools of thoughts - even Marxists and Austrians occasionally have something worthwhile to say.


  1. Great post. Thx HishamH.
    A great summary of economics ideas.

    I like Joseph Schumpeter's ideas on creative destruction and his explanation on the role of profits. Also like endogeneous growth theory.
    Haha, maybe this is because I'm an engineer in semiconductor industry (who happens to take some course on investment analysis).

    Great. I think we have many similarities in opinions.
    I also believe "markets do fail" - information asymmety + stuffs in institutional economics.

    I like your contextual, pragmatic approach. I think that is the correct way.

    "empirical evidence" : I support this too.

  2. You're welcome!

    Be careful! Many engineers go crazy over economics as a science because they can't get over the fact that you can't do controlled experiments, which means empirical evidence has to be taken with a bucket of salt!

  3. Thx for your caution.

    I'll always bear in my mind humans are not always rational (behavioral finance). In science/engineering, there are concepts like fuzzy logic, probabilistic theories (like quantum mechanics). Guess I can deal with "fuzziness", "probabilistic outcome".

    I think there is a branch of economics: experimental economics which deals with experiments, simulations etc..
    As more virtual communities appear in cyberspace (for e.g 2nd Life, Warcraft), that may be a platform for virtual economic experiments :-)

  4. Are you an academic economist or work in industry ?
    What are your curret areas of research ?

    Admire your econs knowledge, so fluent in its usage and expression. Great.

  5. Thanks for the props - I'm in the financial sector, but thankfully not in banks or brokerages.

  6. Haha, those are not props. I really mean it.
    I wish to learn to be able to use econs fluently.

    I like this book “Economic concepts for the social sciences” by Todd Sandler.
    A brief summary of important main economic concepts with economists and their works.

    I think I may like “Law’s order” by David Friedman but don’t have the book yet.

    Do you have any economics related books to recommend ?
    Preferably those that are not so “technical” and easy to digest.

  7. Rather than a book, I suggest you start here:

    That'll give an overview of economic thought. There's a lot of free economic resources available on the web - Wikipedia has a good overview of the main concepts. Is there any particular branch you are interested in looking at?

  8. The website you give is great. Thanks.

    I have been using Wikipedia; the problem is I’m not sure whether the information/knowledge inside is credible. But it’s a good starting point to search for info.

    I wish to learn on those knowledge that can improve my predictive power on economic issues (micro or macro). For example, if certain policies/rules are implemented, what are the likely outcome ?
    Have read a bit on New Institutionalist, Game Theory, micro stuffs.
    Example of predictive model I found amazing:
    Nouriel Roubini predicting US is going into trouble long time back;
    another economist (forget who) once predicts Vietnam is going into trouble based on his model.

    Another direction that I wish to learn is the ideal, efficient system forward (micro, macro).
    Have blogged on Nordish capitalism & Zhou Xiaochuan proposal of changing international monetary system.
    Have read a bit on marginalist stuffs.

  9. Roubini (and Stephen Roach of Morgan Stanley) have been crying wolf for so long, I think people tuned them out. You should note that lots of economists predicted trouble coming - just not quite so loud or so prominently. The other thing is everybody got the transmission mechanism wrong - the smart money was on a collapse of the USD.

    I have no doubt Vietnam will get into trouble too, mainly because there're many historical examples to point to (including us) for the development path they are taking. My bet for the next shoe to fall however is India (too much stress between fiscal policy, monetary policy and the exchange rate).

    As far as predictive models and ideal systems, I think you'll find that there aren't any perfect solutions. Application of policy at the macro level, fiscal or monetary, are sensitive to specific circumtances and I think the experience of the last few years will require a lot of argument and research before the real lessons emerge.

    Micro theory is in a state of flux right now - while there's some promising developments, I don't think there's yet a consensus on what would be a good replacement for homo economicus (rational, utility maximising) as the basis of modelling individual behaviour.

    I don't think you can go wrong however in learning the IS-LM model as a point of departure for macro. It'll at least provide you a comprehensive framework for thinking about policy.

  10. Thx HishamH.

    On Vietnam, I’m referring to the previous crisis. :-)
    Haha, I don’t know how to predict who will be the next in trouble yet. That’s why I find Roubini (and others) and the one predicted Vietnam’s crisis amazing but predictions have a problem. Can only tell a possible direction but cannot predict the time.
    I wonder whether it’s something like “Altman Z score” for countries.
    Thx for your insights on India.

    On good replacement for homo economicus, I think economic theories on information asymmety, new institutional, game theory, behavioral finance might be useful to add on to it.

    IS-LM.. Thx for your advice. Will try to find out more.

  11. for Vietnam to get in trouble again - I don't like the way their currency is so far out of line.

    The problem with predictive econometric models is that you are dealing with very large, dynamic, heterogenous, complex systems that interact with each other. And you also don't have much in terms of the historical record to get a handle on how the "system" behaves under shocks (one advantage the US has is that they collect and make available an enormous amount of data). It's possible to use a panel approach, but then you lose country specific effects and you have to deal with differences in data methodologies.

    Companies have to adhere to accounting standards so balance sheet, profit and loss, and cash flow measures are directly comparable - not so with countries. Plus there are a lot more of companies, so the sample sizes are larger.

    While I have no doubt RGE Monitor uses models, I'd bet that Roubini came up with his diagnosis from a static equilibrium perspective - Roach certainly did.

    The nice thing about the IS-LM model (even if it is a static model), is that you can apply both neo-classical and Keynesian analysis depending on your base assumptions.