Economics, however much economists seem wilfully blind to it, will soon undergo a radical paradigm shift (in the strict Kuhnian sense). The old model of the economically rational actor is coming increasingly untenable as we gather more evidence from behavioral psychology and a new paradigm of behavioral economics will be arriving within the next 10 – 30 years. What is interesting though is how obvious such a shift is from those outside of economics while insiders seem utterly unaware that the foundations they are standing on are crumbling.

Why is it that economists seem so blind to what’s going to happen in economics? There are the standard Kuhnian factors which Kuhn lays out in an exemplary fashion in The Structure of Scientific Revolutions but I think economics also had one other unique factor as well. Economics is a highly non-intuitive science and there is an almost perverse pride in illuminating just how poorly our naive view models the world: Raising the minimum wage decreases well being, trading with people who are universally more efficient than us increases our well being, allowing businesses to fail causes more businesses to suceed. These are all well established parts of the mainstream economics canon and they are all, by and large, true.

But the result of this curious structure of economics is that economists are extremely used to hearing well meaning and sincere economic arguments made by non-economists which are grossly flawed. They’re used to hearing the same shop-worn fallacies assembled to yet again make a seemingly devastating attack on the tenets of economics which, in reality, miss the mark so wide you could fit yo mamma through (sorry, I couldn’t resist). What’s more, these errors are conceptual in nature and to correct them would require indoctrinating the opposing party in the entire philosophy of economics.

As a result, economists have developed a simple zero knowledge proof: At the first obvious sign that the other person is not a complete insider of economics, stop listening and nod politely. And by and large, this is effective. For the vast majority of cases, people jibber jabbering about the evils of globalisation or the benifits of socialism simply have no idea what they are talking about. But the unfortunate side effect of this is that economics as a field has become highly insular and unreceptive to outside influences. In order to mount an effective attack on economics, one needs to be well versed in both the standard economic paradigm and the research methods and corpus of behavioural psychology. There simply aren’t enough people who have the time, intelligence, determination and opportunity to get to that point and, as a result, economics simply isn’t advancing.

Kuhn writes a lot about a crisis point and how paradigms tick over and I think an interesting thing is how the current bailout crisis just might be the crisis point needed for economics to finally start making the transition. The bailout crisis has begun to lay bare some of the fundamentally untenable assumptions of conventional economics and has brought to the forefront radical (to economists) new ways of analyzing human behaviour. Things like non-linear analysis, game theory of groups and incentive structuring theory. Terms like “Black swans” and “tipping points” are being used.

It may seem like such things were in economics already, game theory has been used in economics for decades. But the economics version of game theory was game theory formulated in an economic language. What this shift really represents is economists now being forced to grapple with very different standards of proof and modes of argument. Whether this will herald the beginning of a systematically behavioural view of economics remains yet to be seen.

  • http://www.meme-hazard.org/ Trond Nilsen

    Interesting – it seems trivially obvious, now having read your post, that the Kuhnian idea of changing scientific paradigms is applicable to economics like this, but I’ve never really thought of it that way.

    I wonder – economics, because it’s so widely practiced and laced into our political lives, seems to have more of a ‘folk’ or social component than other sciences. I’m not sure that this will affect paradigm shift in academic economics, but I wonder how long it will take for main-stream uptake of those changing ideas.. That is, how much longer will folk economists take to change, and what effect does that delay have?

    Either way, thought provoking.

  • http://www.meme-hazard.org Trond Nilsen

    Interesting – it seems trivially obvious, now having read your post, that the Kuhnian idea of changing scientific paradigms is applicable to economics like this, but I’ve never really thought of it that way.

    I wonder – economics, because it’s so widely practiced and laced into our political lives, seems to have more of a ‘folk’ or social component than other sciences. I’m not sure that this will affect paradigm shift in academic economics, but I wonder how long it will take for main-stream uptake of those changing ideas.. That is, how much longer will folk economists take to change, and what effect does that delay have?

    Either way, thought provoking.

  • http://www.bumblebeelabs.com/ Hang

    That’s an interesting question. It seems folk economics is driven more than ideology than theory and what I foresee happening is that the Libertarian ideology becoming increasingly more discredited and people from the Socially Liberal ideology selectively taking pieces of evidence from Economics and using it to strengthen their world view.

    One thing I think would be an easy win for the socially liberal is an economically justifiable version of a luxury tax on the basis that happiness depends more on relative wealth than absolute wealth.

  • http://www.bumblebeelabs.com Hang

    That’s an interesting question. It seems folk economics is driven more than ideology than theory and what I foresee happening is that the Libertarian ideology becoming increasingly more discredited and people from the Socially Liberal ideology selectively taking pieces of evidence from Economics and using it to strengthen their world view.

    One thing I think would be an easy win for the socially liberal is an economically justifiable version of a luxury tax on the basis that happiness depends more on relative wealth than absolute wealth.

  • http://t-a-w.blogspot.com/ Tomasz Wegrzanowski

    “Raising the minimum wage decreases well being [...] These are all well established parts of the mainstream economics canon and they are all, by and large, true.”

    Oh, here's a good one because it's so obviously false. This would only be true if demand for low level labour was highly elastic, while in fact it's highly inelastic – so effect of increased wages for the working poor overwhelms any effects of decreased employment. And all research shows no statistically significant effects of minimum wage on employment.

    And yet in spite of both theory and practice supporting minimum wage, economists keep claiming it's a horrible idea.

  • Hang

    Do you have a cite that it's highly inelastic? The relentless quest for ever cheaper labor overseas and the minute sensitivities to currency fluctuations indicate that manufacturing wages at least are highly elastic. It could be that the bulk of highly elastic wages has already been globalized so raising the minimum wage in any one country will do next to nothing since supply will simply shift to another.

    A situation peculiar to America is that the minimum wage is now so low that it applies to very few people. Even Walmart employees are paid close to two times minimum wage.

    When I say by and large true, I mean only in the first approximation sense. There's plenty of room to quibble around the margins and the exceptions may end up outnumbering the non-exceptions in everyday life. But on a gross scale, I'm pretty confident that raising the minimum wage to $30 an hour (adjusted for inflation) is never going to be a smart economic idea.

  • http://t-a-w.blogspot.com/ Tomasz Wegrzanowski

    Just because overdoing something would be a bad idea doesn't mean doing reasonable amounts of it would be too.

    Almost all lowest-paid jobs are in services already, not manufacturing – unskilled manufacturing has already been shipped abroad, as has been all services which could be effectively automated. It will keep happening regardless of minimum wage levels.

    Wikipedia has links to relevant research. In multiple studies 10-20% increases in minimum wage resulted it 0-3% decreases in teenage employment (a proxy for unskilled labour). Reduction would have to be >10% for 10% increase in wages for total incomes of that group to be negatively affected. As such jobs are rarely permanent, so times of unemployment are generally distributed among all working poor, it makes sense to simply consider total income instead of employment status. Employment effects are simply nowhere near approaching income effects.

    Another unrelated effect which is strangely always ignored in this discussion is government aid for the working poor, which effectively constitutes subsidies for badly paid jobs, increasing taxes and creating disincentives for the rest of the economy. Is it a better idea to tax McDonalds extra and pay its employees welfare; make them increase their wages; or tax everyone else to pay for their employees? The answer seems fairly obvious.

    By the way Denmark has $20 hourly minimum wage (all right, it's just $12 PPP), and much lower unemployment than EU average.