Usefulness versus Truth – The Former Matters More

From John Kay’s latest piece – really can’t agree more with it; serves to partially represents how my philosophical world-view has changed in recent years. Also a pseudo-response to Rational Thinker’s excellent comment on my previous post.

“Why Rorty's search for what works has lessons for business
Financial Times 19 June 2007

When a student of business and economics wants to ponder the conceptual foundations of these subjects, Richard Rorty, who died on June 8, is the modern philosopher I recommend.

… What mattered to him was not the search for what is true, but the search for what works. The test of a model, a way of thinking or a theory is not truth but usefulness. …

… The modern economist is driven by physics-envy. Physicists have the best claim to hold a mirror to nature: their models have proved so useful that no one would think about heat, pressure or motion in any other way. Many people claim this is because these theories are true.

…The pragmatic Rorty argued that to say the theories are true adds nothing to the observation that the models are useful. This claim, applied to hard science, is a subject of continuing disagreement. But Rorty’s perspective is surely right for complex and fluid situations whose outcome depends on human interaction. The soldier’s war stories give insight into “The Way the World Is”, but in a very different way from the models of quantum physics. No individual soldier – no general – ever sees the whole picture; no one can ever, in this sense, hold a mirror to nature. The best accounts will eventually come from the military historian or the novelist who pieces together – and manufactures – a narrative from fragments of information and experience. There can be many such accounts, some better than others, none representing a unique correspondence with the truth.

And so it is with business and finance. I have often given an account of an event in business history and been confronted by a participant who offers an account of “The Way It Was”. But all he offers is an account of the way it was for him. Even an aggregation of such accounts can provide only a partial and controversial description of the whole.

… Economists often assert that economic theory says this or predicts that. But economic theory will never hold a mirror to nature. Good economic arguments are specific to their context. There are no universal economic laws, only trends and tendencies.”

The last paragraph is especially agreeable.

Elanor

PS: Also, read Greg Mankiw's nice and insightful paper: The Macroeconomist as Scientist and Engineer. To Rational Thinker again - I guess you are more of a 'scientist', and me an 'engineer' :)

Malaysia's Demise

Hoisted from my previous post; my response to a reader’s comment.

Hi Anon,

I am very sorry about the exclusivity of the post. About North's idea: economists have been increasing technical, relying on model building (equations), mathematics and statistics, to explain economics phenomenons. In a sense it is getting more like physics (disclaimer - this is an extreme oversimplification).

But according to North, while technical constructs are important, to truly appreciate how a country's economy performs, it is absolutely crucial to understand two things: history (what happened before really matters) and institutions (laws, regulations, political structures, social cohesion, mindset of the people, governance, education, corruption).

The more you look at Malaysia, the more you realise how truly true this is - mathematics and models explain very little about economic performance in Malaysia (and when they do explain scenarios, they are always not very interesting). Understanding the true fate of the nation does not lie in looking at the interest rates BNM sets, the exchange rates regime, the inflation rates and so on.

But rather, the fate is determined by what happened before (history) which shaped the institutional structures (institutions) the way we have now. Sometimes history shapes good institutional structures - sometimes it shapes very negative ones. Malaysia, I am increasing convinced, is stuck in a very negative path - we are having a crisis of institution, shaped by our history.

My greatest fear is that this problem is faceless and everywhere - there is no single source. The problem is in all of us, all our organisations, all interlinked together, feeding on each other and giving strength to the decline of our nation. Institutional crisis in Malaysia - the extremely racist mindset, the prevalence of corruption, the need to separate performance-reward structure and replace it with ethnicity/connection-reward structure, the lack of social cohesion, the decline in educational quality - are all linked together, feeding on each other and are not promoted by a single source. No, it is not due to the ruling political party or the oppositions but by our history, our society and every single one of us.

As an example, even without government's direction, our companies have racist policies by themselves - Maybank, and the call by the Bumiputera 'intelligentsia' to retain the racist policies that makes no business/economics-sense is a case in point. The decline is self-sustaining.

If the problem has a single source, the solution is clear - if it is faceless, the solution is… … sigh.

I do not have an answer for that. That is why it is my greatest fear - watching my country's slow but painful demise.

Elanor

PS: Akerlof's latest works is on how to systematically analyse economics by including identity - that is, instead of assuming everyone acting rationally, we have to consider how people will actually act based on their belief on how they should act based on society's expectation of how they should behave. Basically by making economics more personal again.

Look North

"In the analysis of economic performance through time it contained two erroneous assumptions: one that institutions do not matter and two that time does not matter...

...if the institutional framework rewards piracy then piratical organizations will come into existence; and if the institutional framework rewards productive activities then organizations - firms - will come into existence to engage in productive activities."

- Douglass C. North
Economic Performance Through Time, the 1993 Economics Nobel Prize lecture

"Douglass North could be the most important economist of the past fifty years. Yet ... North's work is little known and little recognized, even within the economics profession."

- Arnold Kling

If there is a need to articulate how my world-view on economics has changed after working for 3 years, looking and dealing with economics at a very practical level, is that I now finally could appreciate, empathise and be inspired by the work of Douglass North in a way that I could never do when I was still studying. It is my conviction that the insight is immense and the relevance even greater so, especially for one who aspire to be an applied economist.

Real-life economics analysis and policy cannot be untangled from a true understanding of institutions and norms and the impacts they have on economic performance and the future prosperity of a nation. Malaysians should know this - the most dangerous threat to Malaysia's future is not inflation, unemployment or the next currency/banking crisis, but the slow descent into an overarching but faceless crisis of norms and institutions in the socio-econo-political realm which would eventually lead us to global marginalisation. This, however, is a story for another day.

Back to North's idea, the famous online economist, Arnold Kling (adjunct professor at Cato Institute and previously an economist in FRB and Freddie Mac and author of Learning Economics) wrote this in his latest TCS Daily piece (it is a three-parter, but only the first is out):

Due North
Arnold Kling, 13 June 2007

Douglass North could be the most important economist of the past fifty years. Yet, notwithstanding his Nobel Prize, North's work is little known and little recognized, even within the economics profession.

...The most important economic problems we face are complex systemic issues, such as underdevelopment in Africa or the financial stresses caused by health care spending in the United States. For these sorts of issues, Douglass North is as important as Keynes was to macroeconomics. However, hardly any young economists have followed North's path.

Douglass North calls attention to three factors that are ignored by mainstream economists:

-- Institutions

-- Adaptation

-- Beliefs

In textbook economics, the only external environmental factors that affect the individual are technology and prices. Social norms, habits, and rules play no role. North shows that institutions are fundamental determinants of poverty and prosperity. ...

Textbook economics treats the economy as an allocative mechanism. The focus is on the extent to which resources are allocated efficiently and equitably. North treats the economy as an adaptive mechanism. As an economic historian, his focus is on how an economy evolves over the long term, constrained in many ways by its past. ...

Finally, textbook economics is devoid of cultural context. Mainstream economics assumes that any policy can be implemented anywhere at any time. In contrast, North sees economic behavior as anchored by institutions, which in turn are anchored by beliefs within the culture. ...

But perhaps North's idea is not as unappreciated as Kling conjectured; at least indirectly. Another Nobel Laureate, George Akerlof (Berkeley), together with Rachel Kranton (Maryland), has been very persuasive and forceful in spreading their latest and serious works on norms (identity and beliefs) and macroeconomic theory; which can be said to be an attempt to set economics on a new path, a path that departs from the theoretical foundations of modern macroeconomic models by including social norms for behavior into the theoretical structures. Anyone who are interested in where macroeconomics is heading to in the future should be interested in reading this: Identity and Macroeconomics, What are we missing?

This is taken from Akerlof's presidential address at the 2007 American Economic Association meetings:

The Missing Motivation in Macroeconomics, George A. Akerlof

Abstract
The discovery of five neutralities surprised the economics profession and forced the re-thinking of macroeconomic theory. Those neutralities are: the independence of consumption and current income (given wealth); the independence of investment and finance decisions (the Modigliani-Miller theorem); inflation stability only at the natural rate of unemployment; the ineffectiveness of macro stabilization policy with rational expectations; and Ricardian equivalence. However, each of these surprise results occurs because of missing motivation. The neutralities no longer occur if decision makers have natural norms for how they should behave. This lecture suggests a new agenda for macroeconomics with inclusion of those norms.

Conclusion
... The incorporation of norms based on careful observation imparts an appropriate balance to macroeconomics. The New Classical research program was correct in viewing models of the early Keynesians as too primitive. They had not been sufficiently attentive to the role of human intent in choices regarding consumption, investment, wages and prices. But that research program itself has failed to appreciate the extent to which the Keynesians’ views of macroeconomics were also reflective of reality, since they were based on experience and observation.

A macroeconomics with norms in decision makers’ objective functions combines the best features of the two approaches. It allows for observations regarding how people think they should behave. It also takes due account of the purposefulness of human decisions.

Personally, I find the idea very appealing - a crucial step into a highly exciting direction?

Best,

Elanor

Women

On MIX Breakfast today, Serena C and Ika discussed briefly on marriage and divorce and women in general. At one point, Serena said:

“They say 30’s is the new 20’s now”

Bless her :)

Anyway, the latest IMF’s Finance and Development (June 2007, Vol. 44, No. 2) focuses on the role of women, with the tagline “Unleashing the Economic Power of Women”. The three main articles are:

Smart Economics
Mayra Buvinic and Elizabeth M. King

This issue spotlights gender equality. In the first article on gender, we learn about the progress made so far toward fulfilling the targets set out in the third Millennium Development Goal (MDG3). Not only is MDG3 a vital development objective but it is also key to achieving several of the other MDGs.

Budgeting with Women in Mind
Janet Stotsky

One way for countries to pinpoint policies needed to reduce gender disparities is through gender budgeting, which involves the systematic examination of budget programs and policies for their impact on women. As "Budgeting with Women in Mind" explains, this effort to mainstream gender analysis into government policies has gained prominence in recent years.

Getting All Girls into School
Maureen Lewis and Marlaine Lockheed

Despite important progress in recent years, an estimated 43 million girls around the world are still not enrolled in school. The majority of them are from socially excluded groups. New strategies for educating these "excluded girls" must be found.

There is also an article by Governor Zeti.

And since we are on this topic, this is an interesting TEDtalk by Helen Fisher, on the Science of Love, and the Future of Women. The synopsis:

“Anthropologist Helen Fisher studies love: its evolution, its biochemical foundations and its vital importance to human society. She outlines the three stages of love (lust, infatuation and long-term attachment), shedding light on eternal questions like why we love, and why we cheat. She also discusses the natural talents of women, and their new significance in the modern world. She ends with a warning about the widespread use of antidepressants -- and a truly hilarious story of romantic pursuit.”

Watch it.

Elanor

Arrested Development going Undercover

Undercover economist Tim Harford's latest article on the FT is titled Arrested Development. Unfortunately, it is in no way related to this blog.

An okay read for a Saturday.

Sweet Lizard

My second article on theCicak, adapted from my previous post on Dividing Wealth.

Teehee…

Whole Brain Help

Valued readers,

I need help. I am currently looking for a free online test for the Hermann Brain Dominance Indicator (HBDI) thinking preference model. There is an almost identical one named Neethling Brain Instrument (NBI) whole brain model too.

I have done it before and found out that I am mostly a Blue-Yellow thinker which makes me both a left-right brainer (which mean I get waaay ambiguous results from simplistic left OR right brain test) and a logically chaotic person. Hmmmm.

Anyway, I want to redo the test, but unlike Myers-Briggs Type Indicator (MBTI) tests, I am having problem finding free online test for HBDI.

Can anyone help?

North’s Big Ideas

Important notes of the day… *jot jot*… from Arnold Kling:

Off the top of my head, North's big ideas include:

1. Economics is not ahistorical. You can't just jump arbitrarily from one economic pattern to another. For example, you can't turn Russia or Iraq into a western economy overnight.

2. Institutions evolve from history, technology, and cultural beliefs. And institutions are what lock in economic patterns.

3. If the institutions evolve to reward work and innovation, you will get work and innovation. If they evolve to reward piracy and expropriation, you will get underdevelopment.

If you try to reduce North to a bumper sticker, it would be "Institutions matter." But that phrase alone (which is probably all that most economists know if you ask them about North) does not convey the subtler points of his thinking.

Elanor

Dividing Wealth

We Malaysians are absurdly concerned about dividing wealth. Not redistribution of wealth from the well-to-do to the needy, but plainly about dividing wealth amongst different races, treating wealth as though it is like manna from heaven.

And when it comes to dividing stuff, we inevitably need to impose our judgement on what is equitable – on what proportion is fair. And after much observations, I realised there is a consensus – what is fair is a proportion that relates to the proportion of that race to the total population. I mean, it is totally logical and rational right?

If say you have three adopted sons – Ali, Ah Chong and Muthu – and you want to divide 15 sweets amongst them, it is only fair that each gets 5 sweets. Right?

Okay, let’s inject some realism to this analogy.

1. Wealth is created, not inherited

Let’s add some details to the above story. Say that you are not the owner of the sweets and your adopted sons actually work themselves to earn those sweets. Ali is the most hardworking and diligent, earning 8 sweets. Muthu is next, earning 5 sweets and Ah Chong, being the lazy lad that he is, only managed to work enough to get 2 sweets.

What happens now? Does the notion of fairness as articulated above – dividing equally – still apply? If our notion of fairness is so simplistic, what will happen?

Ah Chong, with only 2 sweets, is the one who needs the most help. So as a parent, you subsidise him – give him more sweets. And since Ali is over 'endowed', you either ignore him or tax him so that you could transfer some of Ali’s sweets to Ah Chong. Muthu, well, you treat him indifferently.

What you are doing, in fact, is to encourage laziness and punish effort. Done often enough, you will breed resentment in Ali, complacency in Ah Chong and promote disunity overall. Since Ali is not rewarded anyway, he might just be less diligent and earn fewer sweets – or perhaps he might just run away from home. Ah Chong, on the other hand, knowing that he will be helped anyway, might as just as well be lazier and be fed the sweets regardless.

And this is the key reason why dividing wealth in such an arbitrary manner is misguided – wealth is created, not inherited. There is no omnipotent Master of Corporate Equity handing out ownerships to the various races in the country, like the parent in the above example. The Government of Malaysia is not the owner of the wealth of the nation, and neither should it be an absolute arbitrator of equity and sorts. A good government is one that facilitates a thriving private sector through good governance and upholding the rule of law, not stifles the sector with silly regulations.

2. Looking Beyond the Racist Perspective

Let’s consider another addition of realism to the example. Now, instead of just 3 sons, you adopted 6 – Ali, Ahmad, Ah Chong, Ah Wong, Muthu and Siva. And now you have 30 sweets (say you accumulated them through a form of savings of sweets from your kids previously). And instead of starting of with nothing, your sons actually have some initial sweets to begin with.

Say, the initial starting points are -

Ali – 20 sweets
Ahmad – 5 sweets
Ah Chong – 23 sweets
Ah Wong – 2 sweets
Muthu – 25 sweets
Siva – 0 sweet

If you are a racist, you will group them together and you get:

Malays – 25 sweets
Chinese – 25 sweets
Indians – 25 sweets

So with your silly notion of racist fairness, you give each race 10 sweets each, and further divide it to 5 per individual. So now you get:

Ali – 25 sweets
Ahmad – 10 sweets
Ah Chong – 28 sweets
Ah Wong – 7 sweets
Muthu – 30 sweets
Siva – 5 sweets

Clearly, this manner of redistribution of sweets results in great inequality if you choose to look beyond the racist perspectives and see them as individuals. Is this what we want? Ah Chong is already rather well off – should we give him more just because he is Chinese? Siva is poor – should we not give him more just because he is Indian?

Let’s blind ourselves and look at our sons as well-to-do and needy:

Well-to-do – 68 sweets
Needy – 7 sweets

Would you redistribute your sweets differently now?

This is the second point – Malaysia has one of the worst inequality of income in the world and the worst in Asia. And the most ironic bit about this is that it is even worse if you look solely at Malays as a group. If we are really driven to eliminate socio-economic inequality, why are we still having indiscriminate policies that help Bumiputera regardless of whether he is a multi-billionaire or not? And why are low income Indians neglected despite the Government knowing well their woes since the very first Malaysia Plan? Because they are Indians and not Malays, and hence do not deserve to be helped even if they desperately need aids? Imagine a 7% discount for a Bumiputera bungalow of RM 5 million – that is RM 350,000 worth of ‘aids’ we are giving to a single Malay multi-millionaire, money that could be used to assist dozens of needy Indian, Malay and Chinese families.

When are we going to truly look beyond ethnicity and address real poverty?

Going back to the beginning, the simplistic notion of fairness and our policies based on this dogmatic pre-occupation of ethno-economic equality – it is both destroying our economic competitiveness and promoting disunity without truly addressing the true issue of socio-economic inequality. When are we going to realise this folly?

Elanor