Elegant simplicity

One of the most widely criticized assumption is also the one that brings elegant simplicity to the subject. The assumption is that we are rational maximisers. That is to say for each one of us maximizes something which economics usually only vaguely labels as “utility”. In theory, utility could be anything, even subjective. Indeed, its roots probably lies in the idea that utility is a proxy for happiness. This is evidenced by the quote “the greatest happiness for the greatest number of people” which is the heart of utilitarianism.

The problem with subjectivity

As with all things subjective, happiness is a very hard thing to measure.  People’s ratings of their own happiness, for example, can be significantly influenced by asking them priming questions.  In one study researchers affected self-assessment of subjects’ happiness by asking them questions about their dating lives before they rated their own happiness.

Even if it were easy to measure, given the proliferation of self help books and gurus, I doubt if we are really happiness maximizers; but I digress.

The homo economicus

Given the difficulty of dealing with subjective definitions of “utility”, most of economics assumes utility to be money or its equivalents. Herein lies the problem – most of us are NOT rational money-maximizers! Paul Krugman in his recent essay titled “How Did Economists Get It So Wrong?” called it “mistaking beauty for truth”. While the assumption makes for beautiful models, it is simply not true.

Study after study has shown that we value the risk of small losses higher than equivalent gains. We value things we own higher than we would have if we didn’t own them. We feel the need to reciprocate any favors bestowed upon us. Even with games like the ultimatum game, people have been shown to incur a cost to themselves to punish others who they think are unjust.

These and more studies on human behavior are littered with evidence for our irrationality. Of course, you won’t find a lot of people (economists excluded) claiming that we are perfectly rational.  This criticism has lead to a caricature of human beings as seen by economists into a separate species called homo economicus.

Economic growth as panacea

These behavioral problems with economics are well known. In fact there are fields of study called behavioral economics  and behavioral finance. Why, then, am I waxing about it? Well, for one, all of us seem to have accepted economic indicators such as GDP and GDP growth rate as the prime measures of well-being. Policy is decided to promote economic growth, we target growth numbers; indeed, we view economic growth as an almost-panacea to all our problems. Don’t get me wrong, I am neither a Luddite nor a communist. However, I do see some problems with this worldview.

Lifting masses out of poverty

We often hear this phrase, that economic growth lifts X million people out of poverty. I am not sure if systematic evidence exists for this. In a very well written article about the ills of pure free market capitalism called “Beyond Selfishness”, Henry Mintzberg, Robert Simons and Kunal Basu argue that growth has actually increased the income disparity in the US. They argue that, in real terms, the lowest class may actually be worse off after growth and that the richest are disproportionately better off. In other words, a gross 8% GDP growth may conceal 125% growth to the ultra-rich and -2% “growth” to the ultra poor.

Of course, some disparity is to be expected. In economics, most of this would be attributed to “productivity”. The argument is probably correct. But the reasoning stops abruptly at productivity. What causes such drastic differences in productivity? Some of it may be attributable to industriousness and inherent abilities of people, but a lot would probably be attributable to opportunity.

Relativity

Another problem with economic growth is that, while a homo economics would be happy if his assets grew in absolute terms, a homo sapien would only be happy if he is better than the homo sapien sitting on the next tree branch! Again, don’t get me wrong, I am not saying absolute growth is not good. I am merely suggesting that, possibly, rat race, lack of leisure time etc., that are hallmarks of our time are probably a result of our mindless pursuit of higher productivity.

But what about happiness?

Our beautiful neighbor up north, Bhutan, has come up with a nice concept christened Gross national happiness. King Jigme Singye Wangchuck , who abdicated his throne to create democracy in Bhutan came up with this concept. Although this suffers from the problem of being vague, it seems like a neat start.

The question remains, while the imaginary homo economicus may be ecstatic at our unwavering focus on growth, what about us, ordinary mortals?