What Are The Economics Of The Situations You Face?

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Thursday, 8.17pm

Sheffield, U.K.

Some say economics has all kinds of good tools and techniques, but it has an absence of interesting problems. I look around the world, and I see all kinds of interesting, important problems we ought to solve with the tools we have. – Alvin E. Roth

There is a term in economics called the production possibility frontier. It essentially says that what you can do is finite – and if you choose to spend your resources doing more of one thing then you will have fewer resources to do something else. If you spend a lot of time reading, for example, you will have less time for exercise and vice versa. Hence the advice for students going to top universities – you will have a choice of doing studies, sports or socialising. Pick any two.

Economics is one of those things that I’ve found useful and perplexing at the same time. For example, why is it so hard to correctly predict what’s going to happen? We’ve been through a few crisis situations since the start of this century. The dot com bust, the housing bubble, the financial crash, the Fukushima nuclear incident and the global pandemic. You start to appreciate some of the issues only after the impacts are clear. For example, the financial crisis had to do with confidence while Fukushima affected demand. The housing bubble has to do with easy credit while the continuing strength of house prices has to do with cheap money. The dot com bust was a technology mania that came too early, and has quietly resumed in the last decade or so. And the global pandemic, apparently, has had next to no effect on rich countries and rich people.

Economists are quite good at putting forward theories as to why what’s happened happened but are there elements that we can use ourselves for day-to-day decision making?

I suppose you could start with the idea of scarcity and having to make tradeoffs. If you want more of one thing, that usually means less of another. That’s simple enough. Except when it’s not. It’s easy to assume that you can’t increase quality and speed without increasing cost – but of course it turns out that you can. The Japanese have been doing that for a while and online platforms, led by Amazon, are leading the way across industries.

Then there’s communication. Information flows are crucial to understanding what’s going on and making decisions. The more you listen and communicate the more likely it is that you’ll make better choices. That goes for our personal lives just as much as it does in business – but it’s not easy to do.

And then there are incentives – ways of nudging people to go one way rather than another. If you make certain things more expensive and other things cheaper or easier then people will start doing things that they might not do otherwise. Or, if you can make them think that it’s a good thing to do then they might do even more.

An interesting example of applying economics to understand a situation is set out in this video by Ashley Hodgson. She constructs an equation that looks at recycling and works through the impact of a single person’s recycling efforts and how it’s affected by the hassle associated with recycling different kinds of material and the social value of being seen as a green, environmentally considerate individual. The thing that’s a little hard to tell is whether the conclusion that you need to make it easier for people to recycle is obvious and the interesting part is hearing it in economics speak or whether the economic model helps you to understand what’s involved in a more effective way. And also whether a different approach, such as a systems dynamics model would work better. But when we get to this point we’re talking about whether we should have a discussion in French or Mandarin – it’s about the language we use rather than the thing we’re trying to understand.

Much of the time the economic principles I’ve learned so far, which are admittedly rudimentary, have been more useful in explaining the past than in modelling the future. At the moment I understand that we could have a future with higher inflation and higher interest rates, which would make things very bad but we could also have a future with low inflation, high growth and low interest rates. Either could happen, we just don’t know which. And I don’t know how useful that is as a way to approach the future.

Perhaps an alternative approach is simply to figure out what you would do if things went bad – figure out your worst case position, put something in place to mitigate that and get on with whatever else you’re working on. Of course, risk management is going to take up scarce resources that you could spend instead on taking on debt and taking risky bets that could result in outsize results or complete failure. Search for Greensill Capital to see how that works as a model.

Those sorts of choices are less about economics and more about what kind of person you are.

Cheers,

Karthik Suresh

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