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Business News/ Opinion / Views/  Opinion | Can economists and universities reinvent economics?

Opinion | Can economists and universities reinvent economics?

The real world is substantially different from the predictable theoretical world described by conventional economic models
  • Universities must embrace some of the new approaches that have emerged and induct these into their curriculum to better prepare their students
  • A file photo of Abhijit Banerjee (Photo: Pradeep Gaur/Mint)Premium
    A file photo of Abhijit Banerjee (Photo: Pradeep Gaur/Mint)

    A few weeks ago, I had lunch with Sanjeev Sanyal, principal economic adviser to the government of India. Our conversation touched upon different topics, and ultimately found its way to a question that both of us find most intriguing: can the discipline of economics re-invent itself for today’s complex world, and can universities embrace a fresh approach to it?

    Economics is not a modern discipline. The first known currency was created around 600 BCE by King Alyattes of Lydia. Arthashastra, the ancient Indian manuscript on economics and politics, is believed to have been written over 2,000 years ago. Even modern economic theory traces its origin back to Adam Smith’s magnum opus, An Inquiry Into The Nature And Causes Of The Wealth Of Nations, published 250 years ago.

    In the world of academia, economics is a particularly rooted discipline. The foundations of the citadel laid by Adam Smith has since been built upon over the decades, by generations of deeply thoughtful scholars such as David Ricardo, John Keynes and Abhijit Banerjee. To pass through its hallowed gates, a rising economist must exhibit proficiency in understanding and applying economic models with great rigour, by producing peer-reviewed scholarly articles published in highly selective journals. Questioning existing models and ways of thinking can be a risky career choice, inconsistent with the largely rational manner in which economists expect individuals to behave.

    But individuals do not always behave rationally. As the Italian economist Vilfredo Pareto remarked, people spend some of their time taking non-rational decisions, and the rest of their time rationalizing them. Assumptions that are inherent in conventional economic models, such as ceteris paribus (other things being equal) are not always valid. Macroeconomics is not simply the aggregate of actions by individuals; it is shaped by interactions among people as well. In short, the complex real world, as we know it, is substantially different from the predictable theoretical world described by conventional economic models.

    Economists often draw comfort from a reversion to the mean: Individuals may act irrationally due to biases and other reasons, but they are inherently rational; or the financial crisis of 2008 was an aberration, but in due course the economic system will find its equilibrium. But Friedrich von Hayek, the Nobel prize-winning economist, believed that there are no laws in economics; only patterns, and we must learn to recognize these. Doing so involves breaking away from a Newtonian mindset of definitive and predictive models and equilibria, and approaching the study of economics from a fundamentally different perspective.

    Several new approaches, such as network analysis or the theory of complex adaptive systems, have emerged. These envision the economy not as a system in equilibrium, but as one that is constantly evolving. Such a system is composed of individuals and their non-linear interactions. A small change in initial conditions can lead to a substantial change in outcomes, or vice-versa. Edward Lorenz, the meteorologist, famously illustrated this non-linearity with the claim that a butterfly flapping its wings in Brazil could cause a tornado in Texas.

    In contrast to the pursuit of optimal outcomes, the way to deal with complex systems is to explore a number of alternatives until one meets a threshold of acceptability. Herbert Simon, who won a Nobel Prize in economics as well as the Turing Award for computer science, introduced the word “satisficing" to describe this approach. This differs starkly from the conventional optimization approach. For example, in the latter case, firms operate to maximize profits to an optimum level. But a satisficing firm seeks to meet a threshold level of profit, after which it pursues other goals.

    Yet another approach is that of network analysis, which is to model the economy as a set of inter-connected nodes in a network. Albert-László Barabási introduced the concept of scale-free networks, where most nodes of the network have only a few links, but a handful of nodes have a very large number. Network theory can be used to study how epidemics spread just as effectively as they can be used to model the spread of financial market contagion.

    These new approaches to economics are gradually starting to flow into the mainstream. The New York-based Institute for New Economic Thinking was set up in the aftermath of the 2008 crisis, primarily to challenge economic orthodoxy. Closer home, folks like Sanjeev are starting to apply the complex systems approach to initiatives such as Swachh Bharat and the Insolvency and Bankruptcy Code. Applying the network approach could help us quarantine financial companies in order to prevent contagion.

    Policymakers are beginning to accept that they may not be able to mandate something and expect it to happen predictably, as one might in the ideal world of conventional economics. As Hayek advises, we must attempt not to shape results as a craftsman shapes his handiwork, but rather to cultivate growth by providing the appropriate environment, as a gardener does for plants. Universities must embrace these practical approaches to economics, induct them into the curriculum, and encourage students to study real-world problems and seek answers.

    Kapil Viswanathan is vice-chairman of Krea University

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    Published: 21 Nov 2019, 11:51 PM IST
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