Everything You Learnt Is Wrong

Blackboard

(Speech given to high school students of Economics last year). Eight minute read.

It’s nice to meet so many fresh-faced budding economists. You haven’t yet become jaded with the subject as you will when you enter the real world. So let me give you a head-start and tell you how even the basics you are learning is wrong.

Let’s start with micro-economics, which is all about the individual, supply, demand, choices and prices. The basic idea is that demand is unlimited, while supply is limited, and hence prices are needed to correctly balance these competing forces. This seems uncontroversial. But let’s take a closer look.

Demand is usually defined as the willingness and ability to buy at a given price. But where does this willingness or “want” come from? Is there any evidence that this “want” originates from the individual themselves? Well, it seems like most “want” or demand gets manufactured by corporations in order to sell their products. Through overt advertising, and more covert forms of advertising in the media, the desire to buy a product gets instilled into individuals.

Even supposedly savvy people often overlook the covert forms. The most prevalent means is the nexus of news-media. Headlines are taken up by fear-inducing stories of murders, wars in far—off lands and the “despicable” lives of politically-weak minority groups or those from lower socio-economic groups. As a relief to these stories, a colourful and exciting palate of celebrity, sports and product stories are offered up. All these are forms of advertising for products of various sorts, and much news in this space is simply press releases rehashed as news.

Let me give you a stark example, movies. Every year hundreds of movies are made, you have no idea what they will be, nor in general do you know whether they are any good. One can rely on movie critics, but they may be biased in order to get pre-screenings, or you could hope that the combination of actors, directors and writers means the movie could be good or ideally you could wait for someone you know to watch the movie and tell you what they think.

But why should movie studios take the risk of the latter, it makes sense for them to encourage you to watch it on the first weekend to take away the word-of-mouth effect. The way they do this is to have a marketing blitz, where posters appear everywhere, trailers with the best bits released; some leaks about how extreme some of the scenes are and the actors hit the talk shows and fill newspaper and magazines with interviews and fun anecdotes. The hype creates the demand for the movie. The end result is that around one-third of the top movies’ grosses over the last 5 years have come from the first weekend [1]!

So people never knew about a movie, never even thought they wanted to watch the movie, then the marketing hype starts and suddenly they “decide” to watch the movie. It wasn’t always like this. Back in the early 1980s, in the days of Star Wars and Indiana Jones only 5% of the gross came from the first weekend – so the word-of-mouth effect was very important.

What about supply? Like demand, we are taught that supply is the willingness to sell at a given price. Let’s take the supply of labour. What wage are you willing to offer your time for? You may think it depends on a trade-off between the income earned and leisure time lost. But you forget that most people are either renting or have a mortgage – around 80% in the US. The average residence is a detached, 3 bedrooms, 2 bathroom, 1500 square feet house built in the 1960s [2].

What’s the implication of this? Well, it means that a basic human need of shelter is not being met fully – or there is uncertainty around it. According to Maslow’ s hierarchy of needs, the first human need is physiological needs (eg eating), the second is safety (eg shelter), the third is belonging (eg family), the fourth is esteem (eg being respected), and final is realising your potential. What this means is that as most people have a mortgage, they are much more likely to stay in jobs that take them away from their family and friends or even harm their self-esteem if it means keeping up one’s mortgage payment. Therefore, the willingness to offer labour for a wage is not necessarily done from a position of strength for the employee. If anything it smacks of indentured servitude or dare I say it, slavery!

So we have supply and demand, then we have choices. Textbooks state that individuals are rational so they will make sensible and consistent decisions. Again reality differs, for example, experiments show that people suffer from loss aversion. This is where people behave differently of they are facing a loss compared to a gain even if the outcomes are the same,

For example a study was a conducted on teachers and their bonuses [3] . One set of teachers would be paid $8000 if their students did well at the end of the year, while another set would be paid $8000 upfront, but would lose it if their students did not do well. So the end outcome is the same for both: students do well you get $8,000, otherwise not. What they found was that the teachers who were paid upfront worked much better and their students did better. It would seem that losing something caused a different behavior from winning something. Irrational but true, and marketers love to exploit this offering free trials.

Another irrationality is the so-called anchoring effect. Let me explain by an experiment again [4] . People were asked to value some chocolate. But before assessing the value, each person was asked to read the last 2 numbers of their social security numbers. What they found was that the people with the higher numbers would value the chocolate between 60%-120% more than those with low numbers! The social security numbers were acting as anchors or reference numbers to base your valuations off. Again marketers use this all the time, especially in the sales, where the pre-sale price is shown next to the “new” price.

There’s more I can talk about, but let me switch to macro-economics. The basic teaching is that a market-based economy will outperform a centrally planned economy – the demise of the Soviet Union, the poor state of Cuba and North Korea compared to the vibrant US and European economies are testament to that. Or so you think!

Let’s take a closer look at the biggest economy in the world, the US. Does it conform to the theoretical ideal of perfect competition with thousands of price-taking firms, thousands of utility-maximising consumers and prices determining the allocation of resources? No! In fact, 60% of workers in the US work in large companies [5] , which mean that managers are deciding or centrally planning the allocation of resources, not market prices. Moreover, on average 50 firms control one-third of each economic sector [6]. Finally, the biggest firm in the US by revenue is the military. It has annual revenue of $700bn [7] , which compares to $470bn for the next largest Wal-Mart [8] . And the US Military is highly centrally planned, with free accommodation, education and health for most within – a socialist dream.

But you may argue that the US is closer to the ideal than the Soviets were, and that is enough have superior economic success. Well, there is something called the “Index of Economic Freedom” that measures the extent of rule of law, business-friendly regulations, limited government and open markets in most countries [9] . If we apply this to emerging markets and rank them in 2000 to see how they fared since then, we find there is a zero correlation between the level of economic freedom and subsequent real per capita growth. So we see less market-friendly economies Russia, Bangladesh and Romania performed just as well as the more “structurally sound” Peru, Chile and Estonia.

The biggest outlier was China, which is at the poor end of economic freedom, but has grown by a staggering 280% per capita since then. No other large country in history has grown as fast as China has. So what’s their secret? Let me read from the Constitution of the ruling party [10]:

“The Communist Party of China is the vanguard both of the Chinese working class and of the Chinese people and the Chinese nation. It is the core of leadership for the cause of socialism with Chinese characteristics and represents the development trend of China’s advanced productive forces, the orientation of China’s advanced culture and the fundamental interests of the overwhelming majority of the Chinese people. The realization of communism is the highest ideal and ultimate goal of the Party.

The Communist Party of China takes Marxism-Leninism, Mao Zedong Thought, Deng Xiaoping Theory, the important thought of Three Represents and the Scientific Outlook on Development as its guide to action.”

There you go – most of what you learn in macro is also wrong!

I don’t want to put you off economics, so here are two reasons to continue studying economics:

First, economics is religion of our times. It has a belief system that doesn’t seem to require external verification to sustain itself. This is ironic as economics promises utopia in this life rather the next, but rather than the failure of a utopia in this world leading to disbelief in economics, it gets explained away by poor execution. Because of this inability to prove things one way or the other, unlike real science, it is full of sectarianism and ideologues like traditional religions. It has its “prophets” like Adam Smith, David Ricardo, Karl Marx, Alfred Marshall, Paul Samuelson, John Maynard Keynes, and Milton Friedman.

More practically, by learning the dogma and sacred language of economics, it gives one access to the ruling class. Just like traditional religion did in medieval times. So your life-chances are dramatically improved by not being a heretic and denouncing the “faith” of economics.

Second, economics masquerades as being a neutral science which is above politics and morality. But in reality, it is deeply political. So if you want to change the world, it is better to gain credibility by learning the belief system of the day, economics, and then subverting it. The most successful revolutionaries have often come from the establishment/ruling classes [11] .

Bilal

[1] Only Avatar (2009) and the excellent Frozen (2013) broke the mould by making much more on subsequent weekends.Source: www.BoxOfficeMojo.com

[2] American Housing survey for the United States: 2011”, September 2013, US Census

[3] “Enhancing the efficiency of teacher incentives through loss aversion”, Fryer at al (2012)

[4] Dan Ariely conducted this experiment

[5] US Census, 2007

[6] US Census, 2007

[7] US Department of Defense, and includes FBI and NSA.

[8] Fortune magazine

[9] Heritage Foundation and Wall Street Journal.

[10] Revised and adopted at the 18th National Congress of the Communist Party of China in November 2012. Source: Xinhua,

[11] Mahatma Ghandi was the son of minister and was trained as a barrister in London. George Washington was the son of a wealthy plantation owner, he tried to get a commission with the British army before leading the War of Independence. Muhammad was a trusted member of the rulling clan of Mecca, the Quraysh, before he took them on with a new religion (Islam),

 

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