Too little economics caused the crisis/inequality

There seems to be a suggestion that economic principles, and the worlds focus on them, is one main reasons why inequality has risen in a way that many are uncomfortable with.  Furthermore, it is common to hear that the economic principles taught to bankers were at fault for their being a financial crisis.

To me, this illustrates that people do not know what the “economic principles” are – and if they did it would become self-evident that it ignorance of these principles that drives poor policy by government and financial institutions.

Just look at the principals that come under this category.  It merely states that people face trade-offs, and make choices given the incentives they face.  How can these sorts of terms be at fault for causing the crisis, or leading society down a path where they were willing to accept higher inequality?

Dig even further into the most subjective elements of economics – welfare economics.  This is the stuff most economists steer away from – because they are too worried about looking like they will have a firm opinion, instead of just being descriptive (at least that is my excuse).

Look at the welfare theorems – they state that, under a given set of conditions with some initial endowments, people will trade and prices will adjust to give us so that no-one can be better off without making someone else worse off.  And on top of that, the government can transfer some of the initial endowment and voluntary trade will lead us down a road where the same condition holds (pareto optimality).

Many will then criticise economists for coming up with a model that takes on unrealistic assumption – but instead think of it this way, with this result what can we ask:

  • If we can transfer resources and allow the allocation to change, which transfer gives the outcome that society values the most?
  • Under what conditions do transfers have real effects?
  • In what cases does our result break down – and in what ways does reality represent this?

Given these questions, economists set about to try and frame issues for policy makers.  With an entire frikken set of transparent assumptions, and discussions around the potential trade-offs, they aim to provide a mixed platter for society to pick from.

And what happens instead?  People prefer to run around, pretend there are no trade-offs, lie about the impact of policy, and then when they face the costs of their actions they just blame other people.  And that is why I say that if people in society accepted scarcity, and understood the basic principles of economics, we would have better policy – and a good argument for more redistrubtion if that (for the cost of some income) was what society wished.

If the teachers have failed, it isn’t because they aren’t being critical enough of the economics establishment – it is because they haven’t been able to make children understand the basic tenant of economics, which is that scarcity exists, and that economics is the study of how to describe scarcity and the allocation of scarce resources in society.

Of course, given that this is stated in the first lecture of all economics courses, I prefer the explanation that the students that walked out of Mankiw’s course were just spoiled brats trying to do something that would make them look cool – after all, I have no doubt that was the incentive they faced.

  • Millinillion

    I think it’s worthwhile distinguishing “absolute” scarcity (i.e. subsistence poverty) which is largely overcome by technological progress. But this generally requires incentives  which (in a market economy) lead to inequality as a byproduct and so “relative” scarcity between people. It seems after a certain point some prefer trade-offs that are not pareto optimal in the strict sense: i.e. in a two person society, they would prefer Ana and Ben with equal wealth after a decision, rather than Ana slightly better off and Ben far better off. 
    Also the intial endowments at any given time include lots of power to one particular group then it might be difficult to redistribute, but that says more about politics than economics. This is my impression of what the Occupy St. Paul’/Wall Street protests are about.
    Finally, it’s great to see those Havard students at least quitting early – there would no doubt have been a wholesale riot when they were suggested to assume, say, universal Cobb-Douglas utility functions for the whole of society.

    Interesting that the Havard class

    • Relative poverty issues are interesting – I find them to be a lot more about attitudes then anything else, and in context making sure there is equality of opportunity seems sufficient for me.

      Absolute poverty is of course a different beast, one that we shouldn’t allow given the amount of wealth and technology we have available.

      Agreed regarding the initial endowment and concentration, these are huge issues – and definitely part of the reason we have redistribution.  I think in essence some of the protesters understand this more than some people writing on the issues.