Economics in Action

Economic history is a bit of an unloved child within economics. Once at the centre of the subject it has fallen by the wayside in the rush to be scientific of recent years. Indeed most undergraduate courses no longer teach any economic history as a core subject and many don’t offer any option whatsoever. So why am I going on about economic history? Well, it turns out it’s very interesting indeed…

A Scientist for Every Issue

What sparked my interest in economic history was actually a book which had very little to do with the past. It was ‘The Cult of Statistical Significance’ by Steven Ziliak and Deirdre McCloskey.  The book was, as you have probably guessed about statistics; furthermore the authors argued that statistics was having a negative effect on the way that economists undertook research. They argued that economists liked to appear scientific and one of the ways to do so was to use statistical significance. A clean cut, simple procedure that gives a right or wrong answer appeals because it seems to offer a degree of certainty to a researcher’s findings. Does smoking lead to an increase in the use of other drugs? Do a t-test and you have your answer. However what exactly does the test of statistical significance prove? The answer, to the authors, was not much.

I am not going to talk more about this debate here (as it is quite technical, divisive and will likely bore the pants off anyone that isn’t interested in doing research in the social and natural sciences). One of the points that I did take away and thought would be interesting to talk about, was that economists can benefit from grounding their work in a wider context.

How to Build a Discipline from the Ground Up

This is where economic history can really play a part. Firstly modern neoclassical economics, the stuff that gives us supply and demand diagrams and the toolkit for how a central bank should be run, is based on a number of key assumptions about the nature of the world. Many of the debates on these assumptions happened over a hundred years ago.

Take for example the theory of value. What should the price of a good be? Should it be decided by how much of each input goes into its production?  Or should it be decided by how much use that people get out of it? Why don’t we just let the market decide and take that as its value? If the first case is true then is the value of the internet, which as a service is very cheap to provide for each user, valueless? Likewise if we use the third option and let the market decide then the internet is still pretty cheap. However, people clearly get a lot out of the internet. It has created a great deal of what economists call consumer surplus; that is what consumers get in value above and beyond the price they pay.

Trial and error, a 10000 year experiment

Secondly it allows us to enrich many of the theories we have to explain the world as it is today. I am currently reading another book (this is the last I will mention I promise!) called ‘Structure and change in economic history’ by Douglas North. In the book he attempts to create a theory which can explain why economies over time fair well and poorly.

For example, we can explain why humans moved from a hunter gatherer society to organised agriculture. For the first million and a half or so years of our history humans occupied a very small area of the globe. There was a lot of space and so as our population grew there was little pressure on hunting resources as new groups or clans could simple move into territory unoccupied by other humans. However, as the world began to be filled up the amount of free space decreased. This caused a decline in the marginal benefit of hunting as there were fewer animals to go around, and there was no incentive for tribes to not exploit all of the animals that surrounded them. If they decided to not hunt a herd or buffalo, some other tribe would. Hunting suffered from what the tragedy of the commons. At some point, the marginal productivity of hunting must have fallen below that of agriculture. When this happened it became in the interest of tribes to start farming, as extra hunters had very little effect on how much game a tribe would catch. Over time agriculture became more and more productive (from breeding crops, improving techniques etc.) and eventually replaced hunting as the main form of food production.

There are no ways of testing such a theory, but it is interesting none the less. It also demonstrates how central property rights and natural resources, two items usually omitted from modern economical analysis, can be in examining the nature of the world.

This post is essentially an extension to my continuing flirtation with game theory and its real-life application.

As our society advances, we have to deal with the consequences of our previous actions. Environmental problems that resulted from unsustainable usage of limited resources on Earth is a prime example of this. Governments and international bodies now put a lot of effort into addressing this issue. The focus has been placed on raising awareness, and it has certainly become somewhat of a social trend (think about the movie Avatar). The question is whether giving people information alone will be enough. Will the knowledge motivate us to act?

It probably will in most cases… assuming everyone has the same moral standard (or can be succumbed to peer pressure). Supposedly moral individuals will act to protect the environment (at the cost of their present material benefits) because they care about the future generations, self-preservation and anything that is morally right. From the game theory perspective, their payoffs from protecting the environment is higher than from not protecting. However, people are different, and we cannot just assume that everyone will behave in a moral for us way. In the end, a person does not have to care about the future if he thinks he has no stakes in it. He will rather use the most of what he can access now and get a higher payoff from polluting. We can call him a selfish moral monster and humanity might become extinct because of his behaviour, but he will be dead by then anyway and does not care. This possibility is very difficult to accept.

Nevertheless, game theory allows this to happen. Game theorists are not concerned with the motives behind each individual action, they care only about the fact it has been chosen (hence must have given a higher payoff). Perhaps, this makes it easier for them to predict all possibilities and incorporate all types of behaviour. Given this, what can we do to protect our environment? In academic circles, the Tragedy of the Commons has been used for a long time to illustrate what will happen if we use resources unsustainably. However, not many focus on the actual solution to the problem, they clearly thought that showing people the problem is enough. We need to rely on something more than people’s morality. Mechanism Design is a branch of game theory that deals with this. It tries to change the conditions of the game in such a way that polluting will directly affect everyone negatively at present. This will in turn prompts each individual, no matter how moral he or she is, to act in the desired way for us.

John Lennon’s famous song Imagine is about the perfect utopian society, which in many sense is a communist society. It is the society most of us dream about. The idea of sharing resources responsibly is so great, but at the same time so unobtainable. However, game theory might just give us a clue on how to solve existing social problems and make little steps towards that imaginary perfect society.

John Lennon – Imagine

There is a very interesting article on BBC News that my colleague Inna has referred me to. It talks about how the small bottled water industry has managed to grow in the last 40 years. This looks nothing special unless you think about the fact that water is essentially free. You can quite easily drink tap water and will not feel any difference from the bottled water. However, people still spend billions of pounds each year on this natural beverage. So here is the irony, we are paying for things we can get for free. Is economic theory about rationality failing here? It is not according to the article.

So, where does the trick lie? Apparently, it is all about branding and marketing (although some bottles water executives disagree). Apart from the convenient packaging, people are supposedly buying trendy brands. I guess in the end we do derive different types of utility from the same resource. Marketing in this case plays a huge role in the market growth.

This paradox does not completely ruin our perception of Economics, but it does make us realise that there are still many things we do not understand.

Nowadays, environment and sustainability is on everyone’s mind. The idea of not having clean water to drink or clean air to breathe is terrifying, yet we are not doing enough to make significant changes. Governments of the world are still fighting with each other instead of working together on the issue. Perhaps it is time we took the matter in our hands and started acting. Luckily, there is an organisation dedicated to this cause.

Oikos is an international student organisation for sustainable economics and management. They have local chapters located at universities in Europe and beyond, counting more than 50’000 students of Economics and Management. In addition Oikos is working with PhD Students and Faculty from across the globe and welcomes a growing Alumni community.

Visit their website to find out how you can get involved.

In 2005, HM Treasury appointed Sir Nicholas Stern, an economist, to report on climate change. Stern calls climate change ‘the worst market failure the world has ever seen’ and states three main goals to overcome it; (i) the pricing of carbon through tax, trading and regulation (ii) a policy which supports and encourages low carbon technology and (iii) the removal of barriers which lead to energy efficiency along with informing, persuading and educating individuals with regard to climate change.

A relationship between the environment and economics is inevitable as economics is the study of scarce resources, resources that we source from the environment around us. The Stern report, which was published in October 2006, was not the first study to discuss this relationship, however, Stern emphasised the cost of environmental degradation to us in terms of global gross domestic product (GDP, something economists could easily relate to) with shocking results. (more…)

Despite misgivings about the growth of giant retailers, as reviewed in a previous post, the Competition Commission’s new enquiry is unlikely to shake up UK supermarkets any more radically than its earlier probes in 2000 and 2003. Even though it has detected some anti-competitive practices – such as big chains pressuring suppliers to sign exclusive deals, and buying land to stop rivals building stores on it,  the Commission can allow these if consumers are judged to benefit. The ‘Big Four’ can claim they do, through persistently low prices and now from the environmental and nutritional improvements they promise to wring from already lean supply chains.

So why do we still feel uncomfortable stepping through Tesco’s (or Sainsbury’s, Asda’s and Morrisons) ever more prevalent sliding doors, when they can claim to be cutting our bills without crucifying our consciences?

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Sex and drugs could soon be the only item you can’t buy at Tesco, in its UK home market or the increasing number of other countries (China is the latest) to which the supermarket chain now extends.

Tesco accounted for half of the new retail space opened in the UK in 2006 and has tripled its store numbers in the past six years, raising its grocery market share to 31%. (Asda and Sainsbury’s vie for second place with around 16%). Almost 60% of the land bank held by UK supermarket chains for future development also belongs to Tesco, which could raise its market share to 40% if all those sites were turned into new stores.

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