CURRENT PROBLEMS IN ECONOMICS
Neo-classical economics has failed on several fronts simultaneously. This multiple failure led to despair and the re-examination of basic percepts and tenets:
I. The treatment of GOVERNMENT
Government was accorded a special status and special treatment in economic theory (unlike other actors and agents). It was alternatively cast as a saint (seeking to selflessly maximize social welfare) - or as the villain (seeking to perpetuate and increase its power ruthlessly, as in public choice theories). Both views are caricatures of reality. Governments do seek to perpetuate and increase power but they use it mostly to redistribute income and not for self-enrichment.
II. TECHNOLOGY AND INNOVATION
Economics failed to account for the role of innovation in growth and development. It also ignored the specific nature of knowledge industries (where returns increase rather than diminish and network effects prevail). Thus, current economic thinking is woefully inadequate to deal with information monopolies (such as MicroSoft), path dependence and pervasive externalities.
III. Long Term INVESTMENT HORIZONS
Classic cost/benefit analyses fail to tackle very long term investment horizons (periods). Their underlying assumption (the opportunity cost of delayed consumption) fails beyond the investor's useful economic life expectancy. Put more plainly: investors care less about their grandchildren's future than about their own. This is because predictions concerned with the far future are highly uncertain and people refuse to base current decisions on fuzzy "what ifs". This is a problem because many current investments (example: the fight against global warming) are likely to yield results only in the decades ahead. There is no effective method of cost/benefit analysis applicable to such time horizons.
IV. HOMO ECONOMICUS
The economic actor is assumed to be constantly engaged in the rational pursuit of self interest. This is not a realistic model - merely a (useful) approximation. People don't repeat their mistakes systematically (=rationality in economics) and they seek to optimize their preferences (altruism can be such a preference, as well).
Still, many people are non-rational or only nearly rational in certain situations. And the definition of "self-interest" as the pursuit of the fulfillment of preferences is a tautology.
V. CONSUMER CHOICES
How are consumer choices influenced by advertising and by pricing? No one seems to have a clear answer. Advertising is both the dissemination of information and a signal sent to consumers that a certain product is useful and qualitative (otherwise, why would a manufacturer invest in advertising it)? But experiments show that consumer choices are influenced by more than these elements (for instance, by actual visual exposure to advertising).
VI. EXPERIMENTAL ECONOMICS
People do not behave in accordance with the predictions of basic economic theories (such as the standard theory of utility and the theory of general equilibrium). They change their preferences mysteriously and irrationally ("preference reversals"). Moreover, their preferences (as evidenced by their choices and decisions in experimental settings) are incompatible with each other. Either economics is not testable (no experiment to rigorously and validly test it can be designed) - or something is very flawed with the intellectual pillars and models of economics.
VII. TIME INCONSISTENCIES
People tend to lose control of their actions or procrastinate because they place greater importance (greater "weight") on the present and the near future than on the far future. This makes them both irrational and unpredictable.
VIII. POSITIVISM versus PRAGMATISM
Should economics be about the construction and testing of of models, which are consistent with basic assumptions? Or should it revolve around the mining of data for emerging patterns (=rules, "laws")? On the one hand, patterns based on a limited set of data are, by definition, inconclusive and temporary and, therefore, cannot serve as a basis for any "science". On the other hand, models based on assumptions are also temporary because they can (and are bound to) be replaced by new models with new (better?) assumptions.
One way around this apparent quagmire is to put human cognition (=psychology) at the heart of economics. Assuming that the human is immutable and knowable - it should be amenable to scientific treatment. "Prospect theory", "bounded rationality theories" and the study of "hindsight bias" and other cognitive deficiencies are the fruits of this approach.
IX. ECONOMETRICS
Humans and their world are a multi-dimensional, hyper-complex universe. Mathematics (statistics, computational mathematics, information theory, etc.) is ill equipped to deal with such problems. Econometric models are either weak and lack predictive powers or fall into the traps of logical fallacies (such as the "omitted variable bias" or "reverse causality").
Dr. Sam Vaknin is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East. He served as a columnist for Central Europe Review, PopMatters, Bellaonline, and eBookWeb, a United Press International (UPI) Senior Business Correspondent, and the editor of mental health and Central East Europe categories in The Open Directory and Suite101.
Until recently, he served as the Economic Advisor to the Government of Macedonia.
Visit Sam's Web site at http://samvak.tripod.com.