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Economics 101: Questioning conventional economics as we know it

Photo: Tiffany Bailey/flickr

On December 2, Chris Ragan wrote a column for the Globe and Mail titled "Another (Macro) Defense of Econ 101." The link to his column is available here. My brief reply was published in the Globe and Mail on December 13. The full version is below:

Professor Ragan defends conventional (macro) Econ 101 as a pedagogical tool for training students' minds to confront and grapple with the complex economic problems they encounter in their daily lives.

I agree: Econ 101 should begin training the mind to handle complexity. Unfortunately, conventional Econ 101 doesn't do this very well, often stranding one out in abstraction while under the illusion that one's firmly grounded in the real world.

One need go no further than to see this inadequacy reflected in the failure of economists to reconcile the two solitudes of microeconomics (with its emphasis on individual markets) and macroeconomics (with its focus on the emergent effects of the assemblage of all markets, such as unemployment and inflation). The macroeconomy is just not the aggregation of the micro, the sum of its parts behaving as though in isolation, but the complex interactions of the parts, often resulting in unintended consequences or paradoxes.

One attempt to reconcile micro and macro, the microfoundations project, was discredited by the 2008 financial crisis. Quoting Paul Krugman in 2009, "there was nothing in the prevailing models suggesting the kind of collapse that happened last year." This has been the greatest professional embarrassment faced by the economics discipline since its handling of stagflation in the 1970s, leading the Queen to summon economists to explain themselves.

There are at least three explanations for the failure of the microfoundations project, and they can be traced back to the content of conventional Econ 101.

Human behaviour. The homo economicus assumption taught in Econ 101 of the self-interested rational super calculator fell out of favour even with the arch-libertarian Alan Greenspan, who expressed shock that American bankers did not self-regulate in a dangerous game of hot potato that ultimately collapsed.

Institutions. The role of social norms, shared beliefs, or "rules of the game" are largely absent in Econ 101 and are often depicted as costly imperfections to the economy rather than as structures keeping it on the rails. Ironically, institutions explain the perverse incentives that nudged many American mortgage lenders away from prudent monitoring of their loan portfolios, fuelling the subprime mortgage crisis.

History.  While there are analytic advantages to separating the flow of time into the short and long run, there is the risk of losing sight that the actual experienced moment of time features both the short and long run. As a result, historical time and by extension, history, get marginalized. Professor Ragan obviously recognizes the importance of history, as is evident in his November 18 column on "hysteresis," which explains how the long run path of the macroeconomy can be influenced by disruptions in the short run, such as the 2008 financial crisis. However, it is my experience that the idea of hysteresis is not introduced in Econ 101, as theoretical rigour tends to override analysis of real world historical processes.

Human behavior, institutions and history all contribute to the complexity of macroeconomics and can explain such emergent effects as the paradox of thrift,  that in a nutshell, shows that if all players save en masse, the economy will shrink. These complex realities necessitate complex policies at time when we are confronted with the confounding challenges of climate change, growing income inequality, an aging work force and stagnating growth.

The stakes are high, and some first year students, like the 70 Harvard undergrads who in 2011 walked out of Econ 101, know this and are right to be questioning what they are taught. Teaching Econ 101 should not about preaching from some sacred scriptural text but should rather be more of an evolving conversation among economists, and with their students.

Photo: Tiffany Bailey/flickr

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