Sunday, December 30, 2012

Quotes of the Day: Ronald Coase on Economic Theory

I will sharing snippets of his precious wisdom
But a theory is not like an airline or bus timetable.  We are not interested simply in the accuracy of its predictions.  A theory also serves as a base for thinking.  It helps us to understand what is going on by enabling us to organize our thoughts.  Faced with a choice between a theory which predicts well but gives us little insight into how the system works and one which gives us this insight but predicts badly, I would choose the latter, and I am inclined to think that most economists would do the same.
The above quote has been lifted from Café Hayek’s Don Boudreaux, which is from pages 16-17 of Ronald Coase‘s 1994 collection, Essays on Economics and Economists; specifically, it’s from Coase’s 1981 G. Warren Nutter Lecture in Political Economy, entitled “How Should Economists Choose?”

The point is what really matters is the soundness of the theory rather than its predictability which serves as consequence. For instance, unsound economic theories implemented through social policies may produce the desired effects over the interim...but at a tremendous price or at the expense of the future; look no further than today's lingering crisis in the developed world, which has been a product of the crucible of manifold interventionism via inflationism (boom bust cycles), welfare-warfare state, debt based consumption policies, cronyism and politicization of economic opportunities.

Importantly, theories can be manipulated to suit certain ends, particularly political ends for the benefit of vested interest groups.

This has been one of the recent admonitions of Mr. Coase at the Harvard Business Review (hat tip Prof Mark Thornton)
Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates. But because it is no longer firmly grounded in systematic empirical investigation of the working of the economy, it is hardly up to the task. During most of human history, households and tribes largely lived on their own subsistence economy; their connections to one another and the outside world were tenuous and intermittent. This changed completely with the rise of the commercial society. Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.
(bold mine)

The bottom line is that simplification of a complex world expressed through political means will likely have dire effects on the economy in the fullness of time.

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