HONG KONG – Given the crisis weighing down the world economy and financial markets, it is not surprising that a substantive reconsideration of the principles of modern economics is underway. The profession’s dissident voices, it seems, are finally reaching a wider audience.
For example, the Nobel laureate Ronald H. Coase has complained that microeconomics is filled with black-box models that fail to study the actual contractual relations between firms and markets. He pointed out that when transaction costs are low and property rights are well defined, innovative private contracts might solve collective-action problems such as pollution; but policymakers rely largely on fiscal instruments, owing to economists’ obsession with simplistic price theory.
Another Nobel laureate, Paul Krugman, has claimed that macroeconomics over the last three decades has been useless at best and harmful at worst. He argues that economists became blind to catastrophic macro failure because they mistook the beauty or elegance of theoretical models for truth.
Both Coase and Krugman bemoan the neglect of their profession’s patrimony – a tradition dating at least to Adam Smith – that valued grand and unifying theories of political economy and moral philosophy. The contemporary obsession with reductionist and mechanical models seems to have driven the profession from theory toward ideology, putting it out of touch with the real economy.
The simplicity and elegance of micro and macro models make them useful in explaining the price mechanism and the balance or imbalance of key aggregate economic variables. But both models are unable to describe or analyze the actual behavior of key market participants.
For example, the textbook theory of the firm does not examine the structure of corporate contracts, and delegates the study of assets, liabilities, incomes, and expenditures to “accounting.” How can firms be understood without examining the corporate contracts that bring together their stakeholders – that is, their shareholders, bankers, suppliers, customers, and employees – whose complex relationships are manifested in companies’ balance sheets and transaction flows? In concentrating on production and consumption flows, national accounts aggregate or net out such data, thus neglecting the importance of financing and balance-sheet leverage and fragilities.
Indeed, today’s mainstream micro- and macroeconomic models are insufficient for exploring the dynamic and complex interactions among humans, institutions, and nature in our real economy. They fail to answer what Paul Samuelson identified as the key questions for economics – what, how, and for whom are goods and services produced, delivered and sold – and rarely deal with “where” and “when,” either.
The division of economics into macroeconomics (the study of economic performance, structure, behavior, and decision-making at the national, regional, or global level) and microeconomics (the study of resource allocation by households and firms) is fundamentally incomplete and misleading. But there are at least two other divisions in economics that have been neglected: meso-economics and meta-economics.
Meso-economics studies the institutional aspects of the economy that are not captured by micro or macroeconomics. By presupposing perfect competition, complete information, and zero transaction costs, neoclassical economics assumes away the need for institutions like courts, parties, and religions to deal with the economic problems that people, firms, and countries face.
By contrast, the economists Kurt Dopfer, John Foster, and Jason Potts have developed a Macro-Meso-Micro theory of evolutionary economics in which “an economic system is a population of rules, a structure of rules, and a process of rules.” The most important feature of a meso-economic framework is to study the actual web of contracts, formal or informal, in family, corporate, market, civil, and social institutions. Doing so provides a natural linkage between micro and macro, because the micro-level rules and institutions typically imply macro-level consequences.
Meta-economics goes still further, by studying deeper functional aspects of the economy, understood as a complex, interactive, and holistic living system. It asks questions like why an economy is more competitive and sustainable than others, how and why institutions’ governance structures evolve, and how China developed four global-scale supply chains in manufacturing, infrastructure, finance, and government services within such a short period of time.
In order to study the deep hidden principles behind human behavior, meta-economics requires us to adopt an open-minded, systemic, and evolutionary approach, and to recognize the real economy as a complex living system within other systems. This is difficult, because official statistics mismeasure – or simply miss – many of the real economy’s hidden rules and practices.
For example, measurements of GDP currently neglect the costs of natural-resource replacement, pollution, and the destruction of biodiversity. Furthermore, it is common to assume in public policy that what is not easily measured statistically is insignificant or does not exist. Static, linear, and closed analyses applied to open, non-linear, dynamic, and interconnected systems are bound to be faulty and incomplete.
The British economist Fritz Schumacher understood that human institutions, as complex structures with dynamic governance, require systemic analysis. He defined meta-economics as the humanizing of economics by accounting for the imperative of a sustainable environment; thus, he included elements of moral philosophy, psychology, anthropology, and sociology that transcend the boundaries of profit maximization and individual rationality.
Similarly, Eric Beinhocker, at the newly established Institute for New Economic Thinking, argues for “a new way of seeing and understanding the economic world.” Such an approach requires incorporating psychology, anthropology, sociology, history, physics, biology, mathematics, computer science, and other disciplines that study complex adaptive systems.
We believe that the framework of “micro-macro-meso-meta-economics” – what we call “systemnomics” – is a more complete way to analyze human economies, understood as complex living systems evolving within dynamically changing complex natural systems. This is a particularly useful framework for analyzing the evolution of ancient but re-emerging economies such as China and India, which are large enough to have a profound impact on other economies and on our natural environment.
The opinions expressed here are those of the author, not necessarily those of the World Economic Forum. Published in collaboration with Project Syndicate.
Image: Display panel on a commercial building shows the closing price of different stocks. REUTERS/Stringer