I have written a summary of the main arguments of Mian and Sufi in “House of Debt”. This book provides the answer to the question “How does macro-economics need to change, in light of the Global Financial Crisis?” This has been asked of many but none have given a satisfactory answer. Mian and Sufi analysis is to the GFC what Keynes was to the Great Depression — in fact Mian and Sufi provide the first satisfactory explanaton for both events. My full length review is available from SSRN at: http://ssrn.com/abstract=2517476.. Below I provide an excerpt from my review which gives the history of the Global Financial Crisis, linking it causally to the East Asian Crisis. Read More
My extensive survey entitled: “Islamic Economics: A Survey of the Literature” (IESL hereafter) is due to be published as a book shortly. IESL selects from the vast literature on Islamic Economics according to certain guidelines discussed below.
Given the large number of variant definition available, the first issue that arises is “What is Islamic Economics?” This is discussed briefly in the survey. An extensive discussion is provided separately in “Re-defining Islamic Economics”. Originally, economic teachings are embedded within, and not separable from social, political, and spiritual teaching of Islam. However, early twentieth century saw the rise of capitalism and communism as competing economic paradigms for the newly liberated Islamic nations. These historical developments promoting Capitalism, Communism and Socialism as ideal economic systems forced Muslim thinkers to organize Islamic teachings related to economics into a unified body of knowledge to create a genuine alternative to dominant Western models.
Western economic theory is presented as a “positive” theory; a collection of facts. In contrast, a central thesis of IESL is that social science is the study of human experience, and hence is strongly conditioned by history. Modern Western political, economic and social structures have emerged as a consequence of the repudiation of religion associated with the Enlightenment and are based on secular principles (see Origins of Western Social Sciences for details). Many of these are in fact antithetical to Islamic principles, and cannot be adapted to an Islamic society. My article on Islam Versus Economics highlights these differences. Muslim societies achieved freedom from colonial rule towards the middle of the twentieth century and have sought to construct institutions in conformity with Islam. The development of Islamic economics is part of this process of transition away from Western colonial institutions.
The development of modern economics is part of the “Great Transformation” in Europe, where traditional societies were radically transformed to secular capitalist societies. For a brief discussion of the far reaching effects on this transformation on European thought, see “A Summary of Polanyi’s Great Transformation”. In IESL, we argue that the founding principles of Islamic Economics are similar to pre-modern western thought, and entirely different from those upon which modern Western economics is based. There is no possibility of merging the two approaches, or of modifying Western economic theories to arrive at Islamic Economics. One of the goals of this survey is to highlight the contrast between these two approaches to economics.
Many areas where Islamic methodology differs from the dominant Western approach are discussed in the survey. Perhaps the most fundamental is the definition of knowledge itself. The tremendous loss resulting from the promotion of the idea that science is the only definitive source of knowledge is discussed in detail in “The Deification of Science and Its Disastrous Consequences.” In contrast to scientific objectivity and detachment, Islam explicitly prohibits neutrality when injustices are observed. We are required to actively engage with the world to bring about the good, and to eliminate evil. Knowledge is created in this process of engagement with the struggle for good. This attitude informs IESL, which is not a neutral and unbiased report of what is contained in the literature. Rather it is an attempt to guide research towards fruitful directions, in accordance with views spelled out in the survey.
With increasing confidence, researchers in psychological economics have been able to demonstrate that in some situations, individuals do not behave like the homo economicus. Among some relevant attempts, Daniel Kahneman, along with his colleague Amos Tversky, pioneered the field of cognitive heuristics and biases in the late 1970s. Between 1971 and 1984, Kahneman and Tversky published a series of papers exploring the ways human judgment may be distorted when we are making decisions in conditions of uncertainty. Kahneman and Tversky’s book on this subject, Judgement Under Uncertainty: Heuristics and Biases, was too technical. Daniel Kahneman’s book Thinking, Fast and Slow makes these essential ideas approachable for non-academic readers.
Kahneman won the Nobel Prize in Economics for the work on prospect theory that explains how people make decisions that involve risk of loss. Indeed, he has become notable for his work on the psychology of judgment and decision-making, behavioral economics and cognitive psychology. In economic analysis, he introduced insights from cognitive psychology in order to highlight the human behavior under uncertainty. Specifically, his research focuses on dismantling the rational decision maker known as homo economicus.
His research also shows that we have two sorts of thought processes: System 1 and System 2- intuition and reasoning. Intuition or System 1 is faster and has usually strong emotional bonds. It is based on habits that are very difficult to change or manipulate. Reasoning or System 2 turns out to be subject to conscious judgments and attitudes. As a result, System 2 thinks slowly; it considers, evaluates, reasons. However, for Kahneman, the main protagonist of human life is System 1: it is the agent of our automatic and effortless mental responses.
On behalf of the importance of System 1, Kahneman highlights the predictable occurrance of errors of judgment. Indeed, he has cataloged people’s systematic mistakes and non-logical patterns for years on behalf of his belief on the relevance of unconscious errors of reasoning that distort our judgment of the world.
One of the main implications of his research is that the articulation between psychology and economics involves a methodological innovation. Kahnenam, as other researchers in experimental economics, has developed methods for thinking economic behavior in controlled laboratory experiments.
Considering the need to rethink the future of Economics Curriculum, one question still needs to be answered: Can students really learn economics from controlled laboratory experiments?
In my paper of this name (which has been published in Real-World Economics Review, issue no. 61, 26 September 2012, pp. 22-39), I show that the apparently objective concept of scarcity is built on THREE normative assumptions. This argument destroys one of the basic ideas strongly argued in most conventional texts, that economics is a POSITIVE study of facts of our economic existence, and does not involve value judgement. The three normative pillars on which scarcity stands as the fundamental principle of economics are the following:
ONE: Private Property.
This is a cultural norm. For example, the Cherokee constitution states that the lands of the Cherokee Nations shall remain common property. If there is a cultural norm of sharing public resources, then the issue of scarcity would not arise (or at least, would be much less frequent). Anthropologists have shown that there is no starvation in subsistence societies because of strong norms of sharing. If the society as a whole has enough food, then EVERYBODY will get to eat. Note the violent contrast with the private property norm. In conventional economics, the Pareto principle embodies the normative idea that the right to property takes precedence over the right to life. If a poor man is starving, the rich man is NOT obligated to provide for him.
TWO: Consumer Sovereignty
Economists argue the we SHOULD not question consumer preferences as to where they come from and whether they are legitimate. Also, economists argue that we SHOULD design an economic system which fulfills ALL preferences (to the extent possible). Obviously if we differentiate between legitimate demands, and idle desires, scarcity would be much reduced. As Gandhi said, there is enough for everyone’s need, but not enough for everyone’s greed. The noxious NORMATIVE idea that the right of the super-rich to private jets trumps the right of the poor hungry child to bread is what leads to scarcity becoming the foundation of economics. If we change our norms to advocate and encourage simple lifestyles, and also consider the goal of an economic system to be that of taking care of the NEEDS of ALL, instead of maximizing the wealth of the wealthy. the problem of scarcity would not arise.
THREE: WELFARE Lies in fulfillment of desires
Again this is a normative judgment about the purpose of life, which is taken to be fulfillment of desires. If we really study what makes us happy, we find a lot of surprises. Firstly the Easterlin paradox shows that if try to fulfill all desires, this does not lead to increased happiness. Because the normal level rises, and people judge their welfare relative to the average, this creates a futile rat race. Everybody works hard for increased wealth, but in the end no one is happier. Everybody would be better off if we followed the advice of Sonja Lyubomirsky who has written the “How of Happiness” and The Myths of Happiness — these show that the ancient virtues: kindness to others, gratitude for our blessings, compassion, sympathy, commitment etc. lead to long run happiness. The idea of selfish maximization of personal consumption with complete indifference to others lead to long term misery. The normative preference of the economists for the homo economicus model creates an unhappy and lonely society, for those who buy into these assumptions. See for example Lane: The Loss of Happiness in Market Democracies.
Abandoning these hidden normative commitments of economics, by allowing for more public spaces and common property, creating norms of social responsiblity, and encouraging simple lifestyles would remove scarcity as the central economic problem. I have argued this is much greater detail in the paper cited in the first paragraph.
QUOTE FROM FDR: “But while they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings. “
— Societies CHOOSE the economic laws they live by, according to their normative judgments.
Global business has been overwhelmed by the financialisation of wealth. Beyond financial and “rationalization” strategies, social conflicts and tensions have been strengthened as labor relations need to be adjusted to capital mobility and short-run returns. In this historical setting, it is worth noting that, in spite of the enormous literature on financial development and inequality, few attempts have been successful in rethinking the intersection between contemporary financial and labor markets in Economics Curriculum.
Indeed, in the current context of “institutionalized short-termism”, the expansion of global finance contributes to the redefinition of labor relations. Investors and managers have enlarged profits in the context of a business model that favors downsizing and cost reduction at the expense of employment. As labor costs are frequently considered large expense items, corporations must tightly managed and documented those costs in order to minimize risk of non-compliance, particularly public companies. Accordingly the Global Labor Union IUF, the current global business scenario fosters changing working conditions that result from:
- continuous restructuring of companies to generate cash outflow,
- redefinition of workers’ tasks,
- increased outsourcing and casualization to cut costs,
- sell-offs and closures of plants regardless of productivity and profitability,
- deteriorating working conditions in the workplace,
- more control on workers,
- diminished employment security.
Considering this background, we welcome David Weil’s recent book “The Fissured Workplace”. The author highlights that today, the employer-worker relationship has been submitted to delivering value to investors. As Weil’s groundbreaking analysis shows, the result has been an ever-widening income inequality. Weil also proposes ways to modernize regulatory policies and laws so that employers can meet their obligations to workers in the context of profitable business growth.
An interesting video on Weil’s ideas can be found at http://www.hup.harvard.edu/catalog.php?isbn=9780674725447
David Weil. The Fissured Workplace: Why Work Became So Bad for So Many and What Can Be Done to Improve It, Harvard University Press, 2014
Teaching finance without any discussion about the social effects of business models has been the routine in most Economics graduate and undergraduate courses. However, among the main changes in the global financial scenario, the emergence of private equity funds as major transnational employers has resulted from new global business models where companies are managed and traded in order to get short-term returns.
Why teaching the private equity business model matters in any attempt to reshape the Economics Curriculum? Private equity funds currently centralize endowments from banks, institutional investors – also pension funds- and high net worth individuals in order to assume a key-role in high profit investment buyouts. These new investment practices have been overwhelmed by the financialisation of wealth that has reinforced “short-termism” in American and European business. As a consequence of a global wave of mergers and acquisitions, workers have been confronted with over more than $ 1 trillion dollars in concentrated buyout power. In Great Britain, for example, 1 of every 5 employees has been working for a company owned by private equity funds since the middle 2000s (BVCA, 2006).
Private equity funds have significant impact both on how companies are run in the current business environment. On behalf of the role that private equity investors play in many companies’ board of directors, higher expectations for short-term profits subordinate the evolution of labor relations. Among larger companies, private investment funds have been mainly responsible for mergers and acquisitions—a process that can also favor increasing unemployment. Besides, as the private equity fund – as an investment group- decides to sell a business, managers of private equity firms can adopt downsizing strategies with layoffs and other cutbacks to improve the balance sheet and make the company’s short- term profits more attractive to potential buyers.
As managers are committed to short- term profits and the payment of debt, private equity firms must subordinate labor and employment relations to efficiency targets. Under the private equity business model, the generation of cash flows to pay non–equity based fees, dividends and debts after the take-over has usually required growing cost reductions with deep effects on labor relations, employment trends and social rights and benefits. Indeed, short-term returns under this model come at the expense of good jobs, secure pension plans, higher investments in operations and product development, and the upskilling and training of workers.
Some time ago, I wrote a survey of the massive amount of empirical evidence that has accumulated over the past few decades against the hypothesis of utility maximization. Taking this into account would require completely re-writing the microeconomics course. Of course micro serves as the basis for all of economics — current macro theory embodied in DSGE model aggregates all agents into a single consumer who maximized utility in an uncertain environment. Typical trade and growth models are similar in treating welfare according to utility maximization. Thus if this hypothesis is wrong, then all of economic theory needs to be re-considered from foundations. In this context, the following quote is very interesting:
Science is the archetypal empirical endeavour. The theoretical physicist and all-round entertainer Richard Feynman put it best: “It doesn’t matter how beautiful your theory is, it doesn’t matter how smart you are. If it doesn’t agree with the experiment, it’s wrong.” This has been the founding principle of science since its earliest days. Without the painstaking astronomical observations of Tycho Brahe, a sixteenth-century Danish nobleman, Johannes Kepler would not have determined that the planets move in elliptical orbits and Isaac Newton would not have had the foundations on which to build his law of universal gravitation.
quoted from WIRED: Science’s Big Data Problem BY DR. TIMO HANNAY, DIGITAL SCIENCE
Unfortunately, economists have not adhered to these scientific principles, preferring beauty elegance, and brilliant mathematicians to empirical reliability of theories. I recently emailed Kenneth Arrow a copy of my survey. He was kind enough to respond as follows:
Dear Dr. Zaman:
Thank you for the very complete and well-argued critique of the utility-maximization theory. Of course, the remaining question is, what should take the place of that theory?
Kenneth J. Arrow
This is indeed the key question: Since utility maximization has been turned into the foundation of economic theory, replacing it requires re-thinking the discipline from scratch. Of course, there is much guidance available — economists were not so strongly wedded to this mathematical theory in earlier times, and a number of good approaches based on historical and/or institutional methods are available. I myself have a preference for Polanyi’s Methodology, which considers social, political and historical spheres as linked, and considers them in a historical and qualitative approach. David Marsay has provided another answer to Arrow’s challenge. The readers are invited to think this through on there own and suggest how we should proceed to reconstruct economic theory WITHOUT utility maximization.