The Impact of Theory on Practice

The question really is what good did economics ever do that isn’t readily available from common sense? Economics has real world impact (“we are ruled by little else” as Keynes famously said), but where it leads to an impact which is distinctive from one which would result from applied common sense, the impact appears to be invariably bad. Of course, definitions of bad may be subjective. It could have two quite separate meanings: bad in the sense that it is counterproductive in its own terms, most usually this would mean damaging to economic growth; or bad in that it does more harm than good in such dimensions as fairness and justice. Examples of bad impacts might include free market economics resulting in great injustice and inequality as well as the creation of inevitably bursting bubbles.

Academic or theoretical economists are producing a prodigious amount of text, which they refer to as ‘research’. There are over 760 universities world-wide producing published economic research. Each university is pressed to produce more in order to gain the funding to produce more still. The Princeton University Press Economics and Finance brochure, for example, lists 188 of their books currently available, covering a wide variety of subject matter, presumably motivated not just by the desire for funding, but also by the pursuit of economic truth. A glance through the Princeton brochure indicates the flavour of current publications: “Supermodularity and Complementarity”, “Advances in Behavioural Finance Vol II”, “Indifference Pricing Theory and Applications”, “The Economic Theory of Annuities” etc, etc, etc.

Previously unresearched topics necessarily become ever more obscure and detailed and ever more distant from the big picture. This ‘research’ activity, which is driven by the need to get published to increase funding, has to produce ‘new’ knowledge. Thus it is driven to examining every feasible nook and cranny of subject matter, deploying undreamed of degrees of magnification to reveal ever greater detail. The potential magnification is infinite. But, as progress is made from one level of detail to the next, the real truth, as well as practical reality, becomes ever more distant.

A fractal, such as the Mandelbrot set, ilustrates the position nicely. The Mandelbrot graphic is infinitely magnifiable as progress is made from one level of detail through to the next and then the next and the next and so on for ever. Using fractal procedures to measure the UK shoreline it can be shown that its length is, in effect, infinite. However, this is neither useful, nor the truth. The UK shoreline, measured along the mean high waterline and including the main islands, is approx. 11,075 miles. We know that is incorrect, but it’s approximately true and close enough to be practically useful.

A recent enquiry in The Economist (referred to in the previous posting on this site) suggested that the recent financial crisis had confirmed prior economic knowledge, such as that a “fall in asset prices tend to reduce the wealth of households, which has a negative impact on consumption.” Similarly, that “capital losses on their assets reduce the credit worthiness of businesses which raises their borrowing costs and reduces investment.” It is not clear what it is about these assertions that qualifies them as ‘economic knowledge’, rather than obvious common sense. And it is still far from clear what good useful knowledge economics has ever provided beyond what was already available through common sense. Apart, that is, from the training of the mind as part of a liberal education for the theoreticians in their ivory towers.