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:

  1. continuous restructuring of companies  to generate cash outflow,
  2. redefinition of workers’ tasks,
  3. increased outsourcing and casualization to cut costs,
  4. sell-offs and closures of plants regardless of productivity and profitability,
  5. deteriorating working conditions in the workplace,
  6. more control on workers,
  7. 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

 Book reference:

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?
Yours truly
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.

I have recently written a paper that I am quite excited about — in a sense it says nothing new, only providing the internal skeleton on which Polanyi;s analysis of capitalism rests. At the same time it i new and exciting in the sense that the methodology implicit in Polany’s analysis is light years away from any of the existing conventional methodologies for social science, and gives us a new, integrated way for looking at and analyzing the world unfolding around us.

Abstract: Polanyi’s book on The Great Transformation provides an analysis of the emergence and significance of capitalist economic structures which differs radically from those currently universally taught in economic textbooks. This analysis is based on a methodological approach which is also radically different from existing methodologies for doing economics, and more generally social science. This methodology is used by Polanyi without explicit articulation. Our goal in this article is to articulate the methodology used in this book to bring out the several dimensions on which it differs from current approaches to social science. Among the key differences, Polanyi provides substantial scope for human agency and capabilities to change the course of history. He also shows that the social, political and economic spheres of human existence are deeply interlinked and cannot be analyzed in isolation, as current approaches assume.

The paper itself can be downloaded from the following link:

http://ssrn.com/abstract=2457299

I have provided a summary of the main points made in the paper on the RWER blog — please see my post:  Polanyi’s Methodology in the Great Transformation.

The concept of capital has been a controversial issue at the heart of Economics Education since the conceptualization of capital enhances deep implications on the apprehension of the economic, social and political dimensions of reality.

Thomas Piketty’s book has been worldwide discussed on behalf of his data sets and explanation for increasing disparities in wealth and income in the context of neoliberalism. Among critical readers of Piketty’s analysis to explain growing inequality, David’s Harvey concern pointed out that his argument relies on a mistaken definition of capital. In short, although there is much that is valuable in Piketty’s data sets, his explanation seems to be founded on a neoclassical theoretical background where capital is mainly a factor of production.  Indeed,  Piketty defines capital as the stock of all assets held by private individuals, corporations and governments that can be traded in the market (no matter whether these assets are being used or not).

Under Harvey’s approach, the definition of capital as a stock of assets excludes the idea of capital as a social process where money is used to make more money often, but not exclusively, through the exploitation of labor power.

Following Harvey’s concern, we need to highlight that the nexus between the current global scenario and inequality encloses inner tensions between the hypertrophy of finance and the expectations of society about citizenship, labor and income. In the current historical context, labor markets have become a key variable in macroeconomic and business adjustments.  In truth, capital mobility has favored the regulation of social relations based on growing flexibility. In contemporary capitalism, the global institutional architecture has favored capital mobility and short term investment decisions – increasingly subordinated to rules of portfolio risk management. While recent changes in productive organization have been based on competitiveness and corporate governance criteria, job instability and fragile conditions of social protection have forced the reorganization of survival strategies. Thus, workers must redefine their skills or become informal entrepreneurs. Given the decreasing power of workers in recent decades, it is not surprising that both the globalization process and its outcomes have favored  the concentration of wealth and changes in social behavior.

While money is an end in itself, social behavior has been overwhelmed by the “profit motive”, as Karl Polanyi warned in his masterpiece The Great Transformation. Consequently, in the last decades, groups of particular interests have spread and social cohesion has diminished. Growing social violence and civil wars, as Eric Hobsbawm clearly said, are some of the outcomes of the  current relations between national states, the free markets and societies in the global order. Indeed, the conflicts between solidarity and particular interests have revealed the current inner tensions to reshape ethical societies.  The current  challenges to reshape the Economics Curirculum need to be thought in this scenario.

 

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