Economics Matters

Because the world is ruled by little else

Archive for the ‘Misconceptions’ Category

A Brave new Model

leave a comment »

(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

The Curse of the Ground – The Zeroth law of Economics

with 3 comments

Reagan exited office right about at the same time my generation came to this earth. And it would not be an exaggeration to say that we are all Reagan’s children. The idea of student politics, ideology, protests, communism, feminism, liberalism and so many other isms is so alien to our generation. Bill Gates is our God. Technology is our religion. Silicon Valley is our holy land. We dream of freedom and wealth, not equality and power. Except a for a few crazy souls like me, no one even cares about politics and economics. In short we are Happy. And that’s because we are Reagan’s children.
If you had not watched the video yet and wonder what I am talking about, please watch it first. After watching, think for a minute about what Reagan is trying to convey via the first anecdote.
Reagan rightly points out that Socialism has no respect for man’s soul. But the anecdote also points out another more fundamental flaw of Socialism – the fact that it arrogantly refuses to recognize the existence of “scarcity”. Now if we all lived in a garden of eden, the socialists might be right in asking why can’t everyone just have everything they might need. Actually that question would be meaningless for when food and clothing and shelter and all other material comforts are as abundant as air, why would anyone even feel the need for them? Do you feel the need to breathe? *. But alas we don’t live in a garden of Eden. Nature is not a sweet mother whose gifts we naughty children are refusing to share. The earth does not yield grains or throw out minerals on its own.  Nature is stingy. The book of genesis in Bible captures this in a profoundly meaningful verse

And unto Adam he said,Because thou hast hearkened unto the voice of thy wife,and hast eaten of the tree, of which I commanded thee, saying, Thou shalt not eat of it :cursed is the ground for thy sake ; in sorrow shalt thou eat of it all the days of thy life ; thorns also and thistles shall it bring forth to thee ; and thou shalt eat the herb of the field :in the sweat of thy face shalt thou eat bread,till thou return unto the ground ; (Genesis 3:17-3:19)

God cursed the earth for Adam’s original sin. Ever since, man has had to toil on earth in order to survive. The garden of Eden was lost to him forever. If we are going to live, then we are going to have to earn the means to live. The idea that any one has a right to food, clothing or shelter just because he was born, makes no more sense than the right to own a yacht that Reagan is talking about. Yachts are scarce? Well my friend, so is food. If that were not true, Robinson Crusoe’s life would not have made for such a gripping read. Why the hell did he have to try so hard, if food grows on trees as the Socialists believe.
Now you are exaggerating. No one is so stupid as to not understand this simple fact, I hear you say. But believe me, refusal to consider this simple fact is behind most of our problems. Why do we have this never ending stream of rights – “Right to Food“, “Right to Education“, “Right to Health”, “Right to Internet” (Yeah you heard it right) ? Do we ever ask “But How?”, when our politicians promise us these? Do we ever ask who pays for it? Or do people believe that there is something called a Free lunch?
If you say that Socialists are not so stupid to fail to recognise scarcity, that leaves us with only one other explanation. They are evil. They want to live off others. They shamelessly lay claim to things that they played no part in creating.  But as Margaret Thatcher pointed out, there is a problem with this – “You eventually run out of other people’s money”. And that brings us to the second anecdote and why we all have a duty to stop the socialists. Like the chicken in that story, there are few people in this society who generate enormous wealth that benefits all of us. ( If it were not for Bill Gates, Computers would have remained locked up in laboratories with no one except some bearded unix gurus understanding them. Were it not for WalMart, shopping would not have become a hobby ). And when some stupid Robin Hood decides to rob these people and “help” the poor, he is essentially hampering the creation of wealth, without being of any use to the society himself. Who knows how many ideas were killed before birth due to India government’s sadistic controls prior to the 90s? Would the great technological revolution of the 80s and 90s have happened even earlier had the Reagan-Thatcher era arrived earlier?
Some economists pretend that taxes have no effect upon productivity. If the guy wants to earn more, let him work more. What is the harm in taxing him higher, he still ends up with more money than he had originally. So he will still work, they say. But men have even more complex needs than that simple chicken. To understand the logic behind why “Atlas” will shrug one day, we need to explore the concept called Opportunity cost. But let us keep that for another day. I leave you now with this thought from Mark Twain

Don’t go about saying that the world owes you a living. The world owes you nothing. It was here first.

Noted in Passing:
* You do feel the need to breathe, when air is in short supply, like under water or high altitudes. Then laws of economics will begin to apply to air too. Researchers living in such extreme conditions are forced to treat air as an economic good and manage their oxygen cylinders economically.

Enhanced by Zemanta

Written by Surya

September 16, 2010 at 6:47 pm

Devil’s Advocate – I

with 4 comments

There is one thing I don’t understand about the Socialist utopia. Everyone will have food,clothes, houses, the morning Hindu, free IPL tickets etc etc. But think about the average dweller. All around him he sees the same kind of houses. Every month he gets the same pay, same as everyone else, same always. Every girl around is wearing the same damn dress. And of course everyone loves all his fellow men and loves to kiss all their a##es.
Seems heavenly indeed. But I want no part of that. Let me rot in this greedy capitalist hell. I love differences. I appreciate inequality. And more than anything else I always love a good debate. So let me go ahead and start a few on the issues where I feel there is a mind numbing confromity of views. In fact to make matters easier, I would play the Devil’s advocate.
1. The %$%$%$%$  Rupee Spectrum scam:
Before discussing the issue, we need to know the data first. So what is the issue here. A corrupt central minister cost the exchequer nearly 10,000 Cr. No wait it is 30000 Cr. No no 60000 Crore. Well can someone give me a number? No? Of course no. One thing I don’t understand is, who came up with all these numbers? The logic seems to be, now that the government has garnered for itself funds to the tune of 67,000Crores from 3G allocation, if it had done the same for 2G too, we would all have been richer by some 60,000 Crore. (Again this linear reverse calculation of possible price is senseless )
Wrong. We would have been all the more poorer. 3G is going to take a real long time to establish itself in India and even if it does it is going to be quite costly. All the mobile operators have emptied their pockets out for the auction. They had to. Business logic dictates that a failure to get the lucrative portion of the spectrum, however high the cost may be, would convert into a huge loss in market share. So most of their bottomlines are hurt. Now who is going to bear these costs ultimately? The consumer of course. The competition towards zero tariff that we are all enjoying in voice and messaging services may never happen or might take a long time to happen in 3G services. Companies will try to maintain a lower bound. But there are still a dozen players in the market and competition is inevitable. So they would look to cut costs in other areas. One possible effect could be a freeze in expansion of infrastructure. This again would only hurt the consumers.
Oh my God. Why are you whining so much like you own these companies, I hear you say. Doesn’t government get all the money. Isn’t it our money? Well you wish.
How can one be happy about wealth being transferred from the private economy to the government? The only aim of the politicians is to win the next elections while making some money for themselves. So a part of these funds would disappear into a black hole and the rest would go just to bridge our deficit. Our profilgate, over spending politicians just got a relief for themselves, without changing their habits a bit. And we are celebrating that our deficit is wiped a little. But at whose cost?
Do I have a solution? I hate proposing solutions. I believe it is immoral to tell others what to do with their lives. But I would just postulate what would have happen if a free market lover ( definitely not our current Prime Minister ) comes to power. He would decide that the government played no role in the creation of wireless technology.  So it is wrong to claim the wireless spectrum as it’s property and levy ownership tax for it. The dozen or more telecom companies would then be in a bit of a spot. How to settle the ownership claims among themselves. Well they would have probably formed a consortium (like FICCI ) and worked out property arrangements among themselves through contracts. Any company that owns a part of spectrum would pay all others some amount for their sacrifice of ownership. In this way all the funds would have stayed within the telecom industry and no one would have lost at net. But I am just theorising ( a fancy word for dreaming ). One or other of our businessmen would have sent a delegation to Delhi complaining of foul play by  competitors and requested the government to intervene. Isn’t it more important that your rival suffers, even if it means you suffer a bit too?
(Check Swaminathan Iyer’s views on this topic here. He is my favourite Indian economist- one who actually understands economics as something more than statistics)
2. A tale of two brothers:
Media loves villains. And our political establishment keeps providing them some. Two brothers from Karnataka are the latest and the scariest of the lot. Here are two corrupt politicians who are stealing all our natural resources. If only we could get a few honest bureaucrats to kick them out, our country would be richer.
Well exports are a very funny issue in economics. Sometimes people bereave that the country is exporting less than it imports, we are becoming poorer etc. At other times people complain about resources leaving the country as exports. Both these views have a fundamental flaw. They view the country as one big grocery store. I would love to discuss this particular notion in detail. But in a latter post.
Now to the issue at hand. I am not a paid agent of these people. I do not know them. I have never visited that place and hell I have never been to a mine. And that’s precisely my point. People may be right in saying that these two men have no right over those lands. True. But you and I don’t either. How can we complain that someone is stealing something from us, when we don’t even know what the thing is. To say that all ores are national resources is simply, well to put it mildly Socialistic ( Atrocious is the correct word ). Why should anyone particular resource be classified as national resource? How would you like it if your industry were declared a national resource and all those who profit from it declared criminals. Now don’t say, this is different. Iron ore is a raw natural resource. It is crucial to safety, etc etc. You can come up with any reason you want if you have passed judgement beforehand. Recently Tamilnadu government nationalised ( Yes, that’s the word ) all the schools. How does that sound?
So are these politicians faultless? Most probably not. With the huge power they enjoy, they could have scared competitors out of business. Illegally appropriated someone else’s property etc etc. But are these the reasons they are being hounded? No. Do the rival politicians who hound them want to correct these wrongs. No they want to nationalize them so that these resources will forever stay the personal fiefdom of their sons and daughters. Infact the prime reason why only corrupt people flourish in mining business in this country is the immense number of regulations. We have denied private players a proper chance for decades. It is foolish to believe that in the absence of an owner, a property will stay in public hands. If you believe that, you are under a socialist delusion. Any so called common property is always exploited by the most powerful man around. So nationalization simply transfers wealth from private players who frugally administer the wealth, to corrupt men who do not care heck about it. Why would these politicians care not to mine every tiny bit out without saving for the future, when they know that the mine is not theirs.
In all the history of the world no one has ever washed a rented car. Just remember that.

(To be Continued)

Written by Surya

July 27, 2010 at 4:25 am