In this morning's video, I note that macroeconomics suggests how governments work. But at present, it's almost all based on microeconomics, which is about how individuals, households and companies work. But that's absurd when micro-entities and governments are completely different in terms of purpose, goals, and the tools available to change outcomes. No wonder we're in a mess.
The audio version is here:
The transcript is:
It's no surprise that the economics used by governments don't work. That type of economics is called macroeconomics, where macro means big. The alternative type of economics is microeconomics, where micro unsurprisingly means small.
Now, microeconomics is where most economists think that economic truth is to be found, but microeconomics is an absurd study both in the way in which it's undertaken and the way in which it is taught and the way in which it describes human behavior.
It assumes that we are maximizing human beings who are totally rational and, quite absurdly, that we know everything about our futures, on which we can, therefore, make totally informed decisions.
All of this is, of course, nonsense. And I know that many economists say that as they advance through their subject. They try to relax some of these assumptions to see whether they hold true or not in particular circumstances.
But the truth is, there is almost no major study in economics that is published these days that does not assume that we are rational, that does not assume that we try to maximize our incomes and well-being, which is almost always expressed in monetary terms, and there is almost no study that assumes that we have imperfect information about both our present and our future.
In other words, microeconomics is built on completely irrational foundations. As a consequence, it prescribes things like, markets are great, people are profit maximizers, and we're indifferent to the consequence of our actions on other people, which don't matter to us because who cares what they're about? It's only our well-being that matters.
That microeconomics is then assumed by the vast majority of macroeconomists, who are those who look at the economics of nation-states and governments, to be the foundation on which that macroeconomic theory should be built. So, you take a pile of garbage and you build the whole of another subject on the basis of that pile of garbage. And that's what most of macroeconomics is. I don't believe in that macroeconomics.
I don't even believe it is possible to build macroeconomics on the basis of microeconomics, because to do so is utterly illogical, even if we could find some rationality in that microeconomics on which macroeconomics was built.
Why is that? Well, because the whole of macroeconomics looks at a totally different issue from microeconomics. Microeconomics is about the individual, the firm, or the business. Fundamentally, a tiny worldview.
Macroeconomics has to be about a whole world view, or at least that of a nation-state, and maybe how the nation-state fits into the world as a whole.
In other words, in macroeconomics, those things that microeconomics can completely ignore, like the externalities that our behaviour creates - things like pollution, things like the ill health created by many of the activities undertaken by a lot of companies producing things like alcohol, tobacco, and ultra-processed food, and so on - macroeconomics has to consider those consequences, even though microeconomics says it's quite rational to ignore them. So, if we build macroeconomics on the basis of microeconomics, we compound the errors in microeconomics by pretending that it is somehow rational to continue to ignore all those externalities which microeconomics ignores. Those things that I've just described, the consequences of pollution, and alcohol, and tobacco, and ultra processed food, and whatever else you wish. My point is that, of course, we know that at a macro level, we can't do those things, or rather, we now know that if we do those things, the consequences are extreme.
We're seeing it with regard to the weather and climate change. The world is getting hotter because we ignored the consequences of our microeconomic behaviour in burning vast amounts of carbon. It will take decades to reverse that consequence, even if we can.
And we're seeing the same with regard to things like ultra-processed foods and the use of sugar in excess. The consequences are all around us. People are getting obese. People are getting diabetes. There is more Alzheimer's and dementia because it is believed that that is influenced by the excess consumption of sugar and on and on and on.
Government has to manage those consequences and to build economic theory about that management process on the assumption that we do not need to consider those outcomes is absurd. And yet, when we listen to government ministers talking about policy, it is as if they want to ignore those externalities.
Look at Wes Streeting when he talks about the NHS. He wants to manage healthcare, he says. He wants to manage demand for it. He wants to do that to limit costs because that's a microeconomically rational thing to do.
But he does not talk about how he is going to manage excess alcohol consumption, even though it most definitely has an impact upon depression and obesity and so many other things. He doesn't talk about tackling big sugar, even though a great deal of the demand for the services of the NHS are now driven by that, given that tobacco has, to some degree, been beaten.
He doesn't, therefore, consider the economics that he should be appraising when considering how to manage the NHS. He's still in a microeconomic framework, presuming that those things are all beyond his control. But he's a government minister. He can pass regulation to change those things and therefore change the environment, which of course somebody in the microeconomic world cannot do.
I can't change the law on sugar or alcohol or anything else. It's beyond my ability to do so. And it's beyond yours as well. But for Wes Streeting as a minister, that is not beyond his ability.
The point is, microeconomics assumes that there is a world out there we can't change. And in macroeconomics, there's a world out there that very often can be changed by government. And ministers aren't presuming that's within their power, because macroeconomics as it is taught, does not assume that that will be the case.
We really have to rethink macroeconomics. And thankfully, there are those who are doing so. I would give a special mention to Steve Keen here, but there are most certainly others.
And the point is, that if we rethought macroeconomics we would fundamentally change our approach to the way in which we manage the whole economy and not just things like the Treasury and the Bank of England and interest rates, but everything that impacts on our well-being because economics is about well-being at the end of the day and if we want to focus on it we limit the harms as well as promoting the goods. But right now, those harms don't seem to be on the agenda, and that's a major failing in thinking.
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Like using the basics of microelectronics to design power networks covering a country.
Only an imbecile would do that.
Like using quantum mechanisms at the microscope level of quarks and electrons to design a macroscopic item such as a motor vehicle. Or even a simple object such as a chair. The whole is not just a sum of its tiny parts.
I think this is related to The Fallacy of Composition: when we assume that what is true for a part (of something) is necessarily true for the whole.
e.g when we assume what is true for a household (microeconomics) is necessarily true for the whole country (macroeconomics).
Another example is the Paradox of Thrift: “It is generally considered a good thing for a household to increase its savings. But if all households save more, total spending goes down. A decrease in spending will lead to a decrease in output, and a decrease in employment, which would lead to a decrease in earned incomes. And when earned incomes go down, households cannot afford to save as much, so total savings decrease” (Myatt, 2022)
Sources:
The Macroeconomics Anti-Textbook: A Critical Thinker’s Guide, by Tony Myatt (publ. 17 Nov 2022)
https://www.amazon.co.uk/Macroeconomics-Anti-Textbook-Critical-Thinkers-Guide-ebook/dp/B0BGKPGGBX/
Crisis and Myth: Why Politicians Must Stop Comparing the UK Economy to ‘Running a Household’, by Jack Mosse, in Byline Times, 1 September 2022
https://bylinetimes.com/2022/09/01/politics-has-been-captured-by-economic-fallacies/
“The household fallacy“, Roger Farmer and Pawel Zabczyk, Economics Letters, 2018, vol. 169, issue C, 83-86 (full text)
https://www.sciencedirect.com/science/article/abs/pii/S0165176518301915
“A government is not a household“, Frank van Lerven, Andrew Jackson, New Economics Foundation, 26 October 2018
https://neweconomics.org/2018/10/a-government-is-not-a-household
“Government-Household analogy” at Wikipedia
https://en.wikipedia.org/wiki/Government-Household_analogy
“Are Policy Analogies Persuasive? The Household Budget Analogy and Public Support for Austerity“, Lucy Barnes and Timothy Hicks, British Journal of Political Science , Volume 52 , Issue 3 , July 2022 , pp. 1296 – 1314
https://doi.org/10.1017/S0007123421000119
“Governments Are Nothing Like Households“, Frances Coppola, Forbes, Apr 30, 2018
https://www.forbes.com/sites/francescoppola/2018/04/30/governments-are-nothing-like-households/
As usual, much appreciated
The links are very good & demonstrate that politicians are not just “not listening” but ignore anything that might cause their controllers to be upset and/or cause said politicians to question their “beliefs” (= “our market which art in heaven” etc).
This cannot be said often enough.
The reduction in macro concepts helps to move sovereignty to the individual.
There’s this quote from John Gray ‘The New Leviathans: Thoughts after Liberalism’ (2023) p. 142:
‘Humans do not desire the good; the good is whatever they desire’. So easy to exploit.
Mix that with companies and corporations who are legally defined as ‘persons’ with rights and you have a recipe disaster.
Joined up thinking? – well, you can forget about that.
“… we try to maximise our incomes and well-being, which is almost always expressed in monetary terms …”
Even if we’re engaged in this we have politicians who refuse to understand the money we use has circularity because it involves creation and destruction. Instead they operate a divisive policy in which government has to play a “Balancing the B*llocks” game in order to spend but they don’t insist that licenced banks are subject to a similar rule where there has to be sufficient savings in place before they’re allowed to create new money! What does this tell you other than the vast majority of economists exist to create propaganda for the rich and politicians use this as an excuse for their behaviour.
I agree Richard on your analysis. What I find odd is that we have known about externalities for some time. I recall reading about it when I was doing my BSc many years ago. So why has it been ignored? If externalities were added in to costs then some activities would cease and others be reduced. Is that why politicians ignore them?
It paid people to ignore them
That simple
I’m currently reading Ha-Joon Chang’s ‘Edible Economics’ – heartily recommended – lots of interesting stories about food and language that make the economics more, er… palatable.
Chang is a long-time advocate (I’ve read his other books) of what i would call economic history, focusing not on the mathematical modelling of neo-classical economics, but on what has actually worked in the real world (and not just in capitalism). A constant theme is that government intervention works – not only does shaping the legal/financial environment shape business behaviours, it can shape the fundamental ways in which we all tend to see the world.
He’s very good
We see each other occassionally
Microeconomics is, to me a misnomer; it suggests something arcane and complex, like quantum mechanics, which is what micro-economists love to pretend; because they want to claim only they understand how to do it, and are therefore gatekeepers to knowledge of how the economy works; and the last is what they have succeeded in achieving, without ever delivering any usable value to anyone.
Microeconomics should be re-labelled ‘Abstract Economics’. It has no relationship to any phenomena in the real world. It describes a Platonic world of forms that looks coherent and consistent with only one drawback. It doesn’t exist. What Abstract Economists should be doing is figuring out a serious methodology that tests their theories, usable in the real world. They have never managed to do this in over two centuries. There is one reason for this problem. They aren’t clever enough, or alternatively they are barking up the wrong tree, and need a new theory; but they do not seem smart enough to cope with that either; but why should they? They are doing very well for themselves, pretending they are doing something worthwhile.
We are the mugs – for taking them seriously.
Microeconomics always struck me as being best observed rather than theorised over or turned into equations.
There’s a paper from economists Saez and Diamond which seems to start out assuming people are income maximisers
https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.25.4.165
but then finds that there is a revenue maximising rate for even high earners. Not all high earners are the same, some will carry on income maximising but some will settle for a lesser income and presumably a better life. What that better life looks like is up to them.
But this is the key sub-sentence:
“the optimal top tax rate using the current taxable income base
(and ignoring tax externalities) would be and ignoring tax externalities) would be τ * = 1/(1+ 1.5× 0.57)= 54 percent”
Maybe…
Forget the equation. The question to ask is how Saez and Diamond precisely measure a) maximisers, b) ‘better lifers’, and crucially the trade-off between the two. Where is the evidence (the raw data – form and centent, methodology, time frame, size of population and the actual results; all available for both peer review, and repeat experiment)?
Is it really nearly 30 years since Tversky and Kahneman got nobelled for showing we are far from rational creatures? Indeed one could argue that this has been exploited for a century by advertising since the days of behaviourist John Watson, when he moved into advertising following his scandals and eviction from academe. Indeed, a moments reflection on human behaviour marks us as emotional, irrational creatures.
And still economosts assume otherwise – and teach otherwise
David Hume made the point at length in the ‘Treatise of Human Nature’ almost three centuries ago.
I hadn’t heard of them.
Amos Tversky and Daniel Kahneman are credited with launching/ the field of behavioral economics. A summary of their work can be found in Daniel Kahneman’s obituary in the New York Times. https://www.nature.com/articles/d41586-024-01344-6
I also discovered that Daniel Kahneman’s second wife was psychologist Anne Treisman (née Taylor) who was married to one of my fourth or fifth cousins.
Six degrees of separation springs to mind.
Having written this, I am uncertain that it is is ‘on-topic’, but Richard did write:
“We’re seeing it with regard to the weather and climate change. The world is getting hotter because we ignored the consequences of our microeconomic behaviour in burning vast amounts of carbon. It will take decades to reverse that consequence, even if we can.” and it makes a point that should be in everyone’s mind.
I get the impression that the government machine thinks about climate change just from a micro perspective. I just wish they would realise that climate change has to be planned for and it will require resources and planning with timescales far longer than a 5 year Parliamentary term.
The human race currently has sensors that can measure what is happening; we know that Antarctic ice sheets are on the move. We can predict the likely effects on sea-level. Thus, we here can work out what land we are going to loose to the sea. It isn’t just a case of building flood barriers.
From: https://sealevel.nasa.gov/understanding-sea-level/global-sea-level/ice-melt/
“A large fraction of the Earth’s fresh water is frozen: It’s stored in glaciers all around the world, and in both the Greenland and Antarctic ice sheets. When this ice melts or calves off, the water flows into the oceans and sea levels rise. If all glaciers and ice sheets melted, global sea level would rise by more than 195 feet (60 meters). NASA continuously measures the weight of glaciers and ice sheets – with the twin GRACE satellites from 2002 to 2017, and with the GRACE-Follow On satellites since 2018. These satellites unambiguously show that the Greenland and Antarctic ice sheets, as well as the glaciers, are shrinking.”
So that’s London gone!! OK its in the far future in human terms, but shouldn’t we think about life for our descendents? Also, events are happening at a rate that seems to take some climate scientist a bit by surprise.
So that sets an upper limit for planning purposes. You can play with a tool to see the effect of sea-level rise for the UK and other areas; See: https://coastal.climatecentral.org/
Of more immediate concern is the AMOC.
“The Atlantic Meridional Overturning Circulation (AMOC) carries warm water north from the Southern Hemisphere, where it releases heat and freezes. The freezing process concentrates salt in the non-frozen portion of the ocean water; this extra-saline water sinks, travels back south and picks up heat again, restarting the conveyor belt. (The Gulf Stream is part of this belt.)”
See https://www.space.com/ocean-tipping-point-atlantic-current-collapse
When the tipping point is going to occur, no-one seems sure yet but one estimate apparently gives 2025.
Then the article states:
“If the AMOC were to collapse in the near future, the consequences would be dire. Without the AMOC, the Northern Hemisphere would get colder, and the southern hemisphere would get warmer, though by a lesser degree . The effects vary by region, but Europe would be hard hit, van Westen said, cooling between 9 and 18 degrees Fahrenheit (5 to 10 degrees Celsius) within a century. That’s a huge swing, even compared with the current level of climate change, which is already having impacts.”
I’ve seen a paper ( https://www.space.com/ocean-current-system-shut-down-2025-climate-disaster They state 2025-2095 limits ) for the tipping point; and another that shows the cold spot over Greenland moving to a position centred just to the north-west of GB. Reversing this, I suggest will be unlikely.
So I suggest a bit of real long-term planning is called for: (macro-planning?). The economic effects will be massive. Countries of Europe will have to become far more self-reliant for survival. I believe that our political system is incapable of achieving this. We just won’t have the energy to support a population of its current size if we carry on as we are.
This grew a bit like topsy, sorry.
Much to agree with
Just on AMOC, I’d always refer to the Potsdam Institute’s Stefan Rahmstorf for the most reliable commentary.
Thanks, just found one paper but yet to read properly. It doesn’t seem to invalidate the point of my post. It still seems to be an important issue. The main area I haven’t seen is info on timescales.
Richard there is much to agree with in this fine post. But there is one massive exception – the dysfunctional real estate market. It is the source of so much inequality and wealth extraction. So huge is this failed market that major macro policy is needed.
One of the most market oriented societies, Singapore, has made a massive intervention which has resulted in 90% of the population owning their residence.
https://www.abc.net.au/news/2024-08-18/singapore-homeownership-sock-yong-phang-henry-george/104237980
[…] Macroeconomics cannot be based on microeconomics Funding the Future […]
I have been reading a book called “Native Nations,” by Kathleen Duval, about the American Indian nations in North America. It appears that the Indians did generally have highly egalitarian, relatively small-scale societies. Interestingly this was true even though they had agriculture, which the standard picture says leads to inequalities of wealth and centralized power in societies. Whether this is because Indian agriculture was run and carried on by women is an interesting question. The men ran relations with other tribes and groups Anyway, from the point of view of this discussion, a sad part of the book (to me, at least) was that these small egalitarian communities were constantly fighting with each other. It is true that famously, one group of 5 (later 6) Indian nations, the Iroquois speakers, after centuries of conflict formed a confederation, the Haudenosaunee, which kept peace among themselves. But then this confederation went abroad urging other Indian nations to join it, and fighting wars with them to make them join if they didn’t agree to. In many cases, the degree of loss of males to warfare was a serious problem. I was personally discouraged to read in Duvall’s book how these Indian nations, whose relatively egalitarian social government structures were appealing in many ways, nevertheless continually fought with each other. Recent archaeological work indicates that preagricultural hunter gatherer groups also commonly fought with each other. People have thought that hunter gatherers were not warlike because the modern African groups, like the !Kung San who were studied so intensively by anthropologists, are not like this. But as has been pointed out, these groups have lived under conditions where they can only inhabit land that agriculturalists or herders do not want They are isolated and kept relatively powerless. The archaeological work finds much evidence of injuries from conflicts at sites of pre-agricultural hunter gatherers. All this seems relevant to the general discussion of how intrinsically benevolent small egalitarian groups are. Of course, it is possible that the different technological circumstances of the groups that would be formed now, would bring about a different set of outcomes. But clearly there is a strong vein of conflict in humans that has to be dealt with.
I admit I am not sure how this relates to this post.
As the old joke goes, microeconomics is wrong about specific things, but macroeconomics is wrong about things in general.
When one considers that virtually all current ‘professional’ economists are intellectual whores, why is one surprised that so much of economics is bunk? But if one considers the goal of modern macroeconomics to be boosting the power and wealth of the elites, well, it is certainly a great success from a practical point of view.
“Modern Monetary Theory: Neither modern, nor monetary, nor (mainly) theoretical ?”
by JOHN Q on JUNE 1, 2020
https://crookedtimber.org/2020/06/01/modern-monetary-theory-neither-modern-nor-monetary-nor-mainly-theoretical/
And a tweak to Amos Tversky and Daniel Kahneman.
“Rank-dependent expected utility
…
“A number of attempts were made to model preferences incorporating probability theory, most notably the original version of prospect theory, presented by Daniel Kahneman and Amos Tversky (1979). However, all such models involved violations of first-order stochastic dominance. In prospect theory, violations of dominance were avoided by the introduction of an ‘editing’ operation, but this gave rise to violations of transitivity.
The crucial idea of rank-dependent expected utility was to overweigh only unlikely extreme outcomes, rather than all unlikely events. Formalising this insight required transformations to be applied to the cumulative probability distribution function, rather than to individual probabilities (Quiggin, 1982, 1993).
The central idea of rank-dependent weightings was then incorporated by Daniel Kahneman and Amos Tversky into prospect theory, and the resulting model was referred to as cumulative prospect theory (Tversky & Kahneman, 1992).
…
https://en.m.wikipedia.org/wiki/Rank-dependent_expected_utility
My answer is “So?”
There is no argument in what you have posted.
Richard KT2’s post was above my pay grade, but I thought Quiggin’s crookedtimber link was an interesting relevant read. And his book is about markets.
Economics in Two Lessons.