The Economics of Everything III: The Math
Author: Joost Haddinga
Can we make it fit into one equation or are we just humans?
Nowadays Economics is Math, or at least Math for a good part. You can be sure, what can be formalized is formalized, with rare exceptions – even behavior as much as possible. But the fathers of Economics would turn in their graves if they got to hear that and others today follow that same path: Economics as a social science, not a natural science. This battle between Mathematical Economics and Philosophical (or Behavioral) Economics deserves its own place, just as to resolve some old misunderstandings and bring some light into the darkness of who is right and who is wrong. So, let’s take a deep dive into The Economics of Everything. This is the third of four parts of this mini-series.
To answer the last question of right and wrong right away in Economics terms: It depends. It depends on your assumptions, your way of seeing humans and the world, on the primary aim of Economics and your own perception. Here we find another easter egg of Economists: models. For every process there is a model, and if there is none yet then it is time to create one: Come up with some formulas, either utility maximization or output variation or a regression equation, depending on the discipline and question to answer. It has not always been like that. Back in the old days, Economics was mainly a science to describe how nations act and interact and what happens (or is beneficial) overall. Only really in the 20th century formulas and equations entered Economics. Since then, a trend has come up to formalize what is possible – putting all ideas into frames. Good for what can be framed, awkward for what cannot be framed: Which value do you ascribe to a life, is price the same as utility and how do you even measure the latter? Speaking of utility, this is how much you value something, even beyond its monetary value – namely in terms of how useful or pleasure-enhancing a good or service is to you.
Another important quest to tackle when introducing mathematics is causality. We live in a complex world, so what determines what and can we be sure that this is the case. Whenever you look at two events apparently linked, remember another Economics classic: Correlation does not equal causation – just because two events run simultaneously or after each other, they needn’t be connected. Solving this brought up a completely new discipline: Econometrics – the metrics for Economics. In this Economists analyze mathematical and statistical conjectures and try to make inferences about the influences of x on y or how two things interact. In how far this is applicable, in how far this is actually solving anything may be questioned. As characterized in Taleb’s “The Black Swan” not all relations are linear, normally distributed, or forecastable. Here are the still the current shortcomings of mathematical economics: not everything can be quantified and even what can be quantified might be sometimes (or quite often) hard to measure or correctly classify.
This is where we enter the side of Economics, away from equations and towards decisions: Ethics and behavior. While the former just deals with a qualitative perspective of how to act in certain situations and what to do when (a question that bears many, many implications, and answers), the other formalizing and integrating human fallacies into economic thinking. In a way this is more back to the roots, back to where we came from and into the direction where Economics really lies: Economics as a Social (Human) Science. This also explains why Economists rarely agree on anything – depending on your view and your expectations on others you may come to completely different decisions: If firms are just responsible for profits, then they needn’t care for the environment; but if there is the responsibility is to make society better, then they need to care as well. The same goes for people: where does your responsibility begin and where does it end? At yourself, your family, your nation, the whole world – and which implications does that bear for living together? Here lies the still unsolved complexities of Economics: It deals with explaining the whole world, but sees that the world is so much, so complex that not everything can be put into logic, formulas, or rational explanations. Some things just are, some things, as in Game Theory, follow conditional logic or have other parameters and might simply not be discovered yet. While some things are really clear, others are not – and what these are we’ll see in the last episode of this series.