Economics Matters

Because the world is ruled by little else

A Brave new Model

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(This was my first post on economics. Moved from my personal blog. I will also move a few other posts on economics that I wrote before starting this blog)

Reality is that which, when you stop believing in it, doesn’t go away.

-Philip K. Dick

The academic community is fond of models. It is true that modeling is the only way to understand several complex phenomena. But I believe that a large part of enthusiasm for models is due to the fact that models permit unconstrained imagination unlike the real world which always comes up with new problems. The theorist who has had a sudden flash of insight hates to be told by the real world that the idea is impractical.

This is not a problem in physical sciences because, however convinced a theorist might be of his/her ideas, he/she has to corroborate it with solid experimental results for it to be accepted. We must be thankful to the early scientists for establishing this tradition of experimentation. This more than anything else has separated quarks from people of real substance. Because ultimately human imagination is unconstrained but the physical world is constrained and people want to live in the real world. So in physical sciences a model is just a convenient tool for finding the truth. It is not the truth itself.

But today, modeling is not limited to the physical sciences. In fact the biggest users of models today are Business leaders, Investment bankers , Economists and so many other ‘practical’ men. It is true that the economy has become too huge for decisions to be made solely on the basis of conventional wisdom. Models are of great practical value in predicting the outcomes of decisions of monumental importance. Whereas the utility of models cannot be questioned, we must not forget the fact that these are still just models and they cannot accurately represent the ever changing nature of reality. It is the failure to grasp this fact that has made the world seem so complex and unpredictable a place than it actually is.

The biggest casualty of this attempt to port a tool of physical sciences into the social realm is economics. It is not exactly clear why economists chose to use mathematical modeling as a tool for economic analysis. It is possible that this was partly motivated by a desire to show themselves as talented as their counterparts in physical sciences. Whatever the reason is, the world has suffered a lot due to this change of direction. Prior to the advent of modeling, the problems of economics were analysed on the basis of human actions. It was understood that the economy is only a sum total of individual actions. Hence it had to be understood only from the standpoint of human behavior. Mathematics and modeling had no place here. But this happy state of affairs was interrupted when a man named Keynes appeared on the scene. Like a pied piper he lured all students of economics away from the real world and into the imaginary world of unlimited money supply and the all encompassing benevolent state. What he preached was fundamentally no different from what Karl Marx had said a century ago. But the same people who recognized communism to be a disgusting idea, celebrated the Keynesian idea of big government. The irony is Keynes himself claimed to be a defender of capitalism and professed to hate socialism, while at the same time preaching ideas that contributed to making Socialism more popular than its proponents could have ever made it.

The biggest problem with Keynesian economics is that it tries to fit human behavior into its model. It assumes that actions of countless individuals can not only be modeled but can also be played around with. It is on the basis of this assumption, that governments and banks try to pump money in and out of the economy trying in vain to make people act the way they want them to. Any parent with a teenaged son/daughter would know that individual behaviour cannot be regulated without the individual’s consent. Parents who attempt to do that end up with rebellious kids who blame their parents for all their misery. The argument that the parents were motivated only by a desire for the children’s welfare is seldom bought by the children. If people who are so close and important to an individual, cannot predict or regulate an individual’s behaviour, how can government planners, sitting thousands of miles away in closed cabins expect to?

Today even physical sciences realise the limits of mathematical modeling. Todays research on artificial intelligence relies heavily upon Fuzzy logic, Neural Networks and Genetic Algorithms. None of this is mathematical in its approach. The scientists have realised that a lot of phenomenon are distributed in nature and are hence inherently imprecise, unpredictable and more importantly constantly evolving in nature. So mathematics is just not the tool for the job.

If people must indeed model economic actions, I would suggest them to take a closer look around while driving their car on a busy morning. Every vehicle around you wants to squeeze the last inch of space available for it. The sole motive of every driver is to reach his/her destination in time. Most of the motives clash. I want to go straight. The car before me wants to take a turn etc. But still most of the people manage to attain their motives. How does this happen? Simple. We start with a few simple rules. Always drive on the left. Stop at signals. Keep at least a feet away from the vehicle at the front. Indicate before turning etc. As long as people stick to these rules everything is smooth. If someone violates, he/she is considered an offender and punished accordingly. So as long as the person next to you is sensible and acts in his/her own self interest, you too can safely reach your destination provided you too act in your own interest.

Now consider what would happen if were to apply mathematical modeling to the traffic regulation problem. Suppose the planners are too irritated by the delay caused by traffic jams. Rather than going for a strict implementation of the traffic rules, they decide to model traffic to prevent problems from happening it all. After all prevention is better than cure, right? So they develop an advanced system that would decide what kind of traffic flow is best for everyone. It averages out everyone’s motives and constraints and provides a fair deal for everyone. You get up in the morning and decide to take a ride to a nearby grocery. But the traffic that day is heavy. So the system calculates that every person should on average take 20 minutes to travel. So to discourage you from travelling in five minutes to the shop and in the process ‘steal’ 15 minutes from your fellow men, it taxes the 5 minute route. On another day, you are in a hurry to reach the hospital. So you want to use your car. But the system calculates that the load will be unmanageable that day and taxes every car that takes the road. If the planner is strict, it might even bar you from using car that day. After all every one has to share their troubles. What happens on a normal day? You have an on board display that tells you how much the system will tax you if you take a particular turn. The tax is directly proportional to the disturbance you will create to the regular traffic by making that turn. As long as people keep travelling straight along with the flow, no one has a problem right? But what about the place you want to reach? That is expendable because it cannot be fitted into the model. Ideal isn’t it? No more traffic jams. A world fair for everyone. I suggest to city planners to start working on this idea soon. They can get the best brains to create a model for them. I am good at mathematics. May be I’ll join too. Long live the brave new model, sorry world.


On second thoughts, traffic is a bad analogy for economic co-operation. Though it fits for the purpose of this article, the analogy should not be extended. While driving in a traffic, the presence of other vehicles only hurts you. The best thing to happen for you would be a completely free highway. But in an economy, our well-being essentially depends on the existence of other players. If very few people engage in productive activities, our standard of living will invariably be low, irrespective of how much effort we put. Taken to the extreme, however hard Robinson Crusoe tries, the one-man economy he lives in, can never lift him out of his animal – like existence. Also note that this only strengthens the case against modelling and excessive regulation. In an economy, there is an inherent harmony of interests amongst various participants ( despite the existence of competition. Your competitor in the industry is the only person whose success might materially harm you. Again lack of competition is also harmful ). So regulation leads only to introduction of problems in an otherwise healthy setup )

Written by Surya

September 21, 2010 at 3:10 am

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