Wednesday, September 2, 2015

What is Conventional Economics?

Conventional Economics is a term I use in N Theory to describe all currently promoted theories of economics. As Jonathan Schlefer in his book, The Assumption Economists Make, states there are three main schools of thought: Rational Expectations; Real Business-cycle Theory; and DSGE (Dynamic Stochastic General Equilibrium). Rational Expectations theory explains people use their judgment about the future based on what they expect to happen. The prominent factors that influence this judgment are product quantities, quality and prices. Real Business-cycle Theory assumes the market chugs along until conditions change. The main conditions are the cost to borrow money, the cost of labor and the size of the market. DSGE puts all these conditions and factors into a predictive model.

In a world with these three theories, what are we left with to evaluate? We could question whether people make rational judgment about the economic future. We could question whether change in the market will affect market performance. We could put all the factors affecting the market into a model and make predictions about how change may affect the market.  Nothing is wrong with any of these approaches, but they do not get us very far and they can be dangerous when used to tell us what to do next. In any case, this is the three groups of ideas I term Conventional Economics.

DSGE theory was a total failure in the Financial Crisis of 2007. One reason for the dismal performance is that is not a theory. It is a technique and a technique without a purpose spits out meaningless hogwash. So let's put it aside and concentrate on the other two theories. History partially supports both. Ingredient labeling on food packaging caused many consumers to rationally reevaluate what they were buying for their families. The Dot Com bubble did not put an end to electronic technological change, or alter the high premiums for companies in that market segment. Both partial theories are valid. We need both the intelligence of the consumer and the durability of the market incorporated into a robust economic theory. Something similar to the DSGE approach can provide insight, but mathematics alone does not explain what is happening in the economy. It is far too simplistic and artificial. Economics is not physics. Economics is about people. People act less uniformly than do subatomic particles.

Here is another insight about Conventional Economics. Economics is the academic study of the marketplace. Why are we studying Economics? The goal is to design a marketplace that provides products and services with employment opportunities sufficient for a satisfying life for the maximum number of people.

Often we get diverted from the goal of creating an improved marketplace. Our leaders take us in a different direction. They focus on the defects in the marketplace. They argue for having power over the shopping environment regulating the slope of sidewalks and the architecture of facades. Power in the economic equation is never good. European socialist countries, Asian communist states and African dictatorships often try to capture the cash proceeds from commerce, and use those funds to support their lifestyle. This tendency results in two approaches to market management. State regulation of the market, or market participant regulation. Participant regulation is the much better approach. It has at least a twenty thousand year history, sufficient time to work out the kinks. Participant management leaves market regulation to the experts. The other part of that equation is that state regulation is always an economic burden. It takes money out of the market to spend on offices, vehicles and salaries for the State regulators. This is the core of Conventional Economics. It is just not theory, but the artifice and bureaucracy created by a government following a specific Economic theory.

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