Capitalistic Musings | Page 2

as the standard theory of utility and the theory
of general equilibrium. Irritatingly for economists, people change their
preferences mysteriously and irrationally. This is called "preference
reversals".
Moreover, people's preferences, as evidenced by their choices and
decisions in carefully controlled experiments, are inconsistent. They
tend to lose control of their actions or procrastinate because they place

greater importance (i.e., greater "weight") on the present and the near
future than on the far future. This makes most people both irrational
and unpredictable.
Either one cannot design an experiment to rigorously and validly test
theorems and conjectures in economics - or something is very flawed
with the intellectual pillars and models of this field.
Neo-classical economics has failed on several fronts simultaneously.
This multiple failure led to despair and the re-examination of basic
precepts and tenets.
Consider this sample of outstanding issues:
Unlike other economic actors and agents, governments are accorded a
special status and receive special treatment in economic theory.
Government is alternately cast as a saint, seeking to selflessly
maximize social welfare - or as the villain, seeking to perpetuate and
increase its power ruthlessly, as per public choice theories.
Both views are caricatures of reality. Governments indeed seek to
perpetuate their clout and increase it - but they do so mostly in order to
redistribute income and rarely for self-enrichment.
Economics also failed until recently to account for the role of
innovation in growth and development. The discipline often 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.
Classic cost/benefit analyses fail to tackle very long term investment
horizons (i.e., periods). Their underlying assumption - the opportunity
cost of delayed consumption - fails when applied beyond the investor's
useful economic life expectancy. People care less about their
grandchildren's future than about their own. This is because predictions
concerned with the far future are highly uncertain and investors refuse
to base current decisions on fuzzy "what ifs".
This is a problem because many current investments, such as the fight
against global warming, are likely to yield results only decades hence.
There is no effective method of cost/benefit analysis applicable to such
time horizons.
How are consumer choices influenced by advertising and by pricing?
No one seems to have a clear answer. Advertising is concerned with the

dissemination of information. Yet it is also a signal sent to consumers
that a certain product is useful and qualitative and that the advertiser's
stability, longevity, and profitability are secure. Advertising
communicates a long term commitment to a winning product by a firm
with deep pockets. This is why patrons react to the level of visual
exposure to advertising - regardless of its content.
Humans may be too multi-dimensional and hyper-complex to be
usefully captured by econometric models. These either lack predictive
powers or lapse into logical fallacies, such as the "omitted variable
bias" or "reverse causality". The former is concerned with important
variables unaccounted for - the latter with reciprocal causation, when
every cause is also caused by its own effect.
These are symptoms of an all-pervasive malaise. Economists are
simply not sure what precisely constitutes their subject matter. Is
economics about the construction and testing of models in accordance
with certain basic assumptions? Or should it revolve around the mining
of data for emerging patterns, rules, and "laws"?
On the one hand, patterns based on limited - or, worse, non-recurrent -
sets of data form a questionable foundation for any kind of "science".
On the other hand, models based on assumptions are also in doubt
because they are bound to be replaced by new models with new,
hopefully improved, assumptions.
One way around this apparent quagmire is to put human cognition (i.e.,
psychology) at the heart of economics. Assuming that being human is
an immutable and knowable constant - it should be amenable to
scientific treatment. "Prospect theory", "bounded rationality theories",
and the study of "hindsight bias" as well as other cognitive deficiencies
are the outcomes of this approach.
To qualify as science, economic theory must satisfy the following
cumulative conditions:
a. All-inclusiveness (anamnetic) - It must encompass, integrate, and
incorporate all the facts known about economic behaviour.
b. Coherence - It must be chronological, structured and causal. It must
explain, for instance, why a certain economic policy leads to specific
economic outcomes - and why.
c. Consistency - It must be self-consistent. Its sub-"units" cannot
contradict one another or go against the grain of the main "theory". It

must also be consistent with the observed phenomena, both those
related to economics and those pertaining to non-economic human
behaviour. It must adequately cope with irrationality and cognitive
deficits.
d. Logical compatibility - It must not violate the