Economics, Sexy is Not

Yoda told me to work the word ‘sex’ into the title of every boring article I post. Marketing guru he is.

My experience studying Economics undergrad had me convinced that the whole discipline had drank the Kool Aid and was suffering en masse from the hallucinatory aftereffects. But as I have aged slightly out of rebellion and spent more time thinking about it, I have come to a realization. Although Econ is not and can never be a predictive science, it is a powerful strategic one.

Remember how 20 years ago everyone always made fun of the weather guy? It was because he was wrong so often that flipping a coin would produce relatively favorable results. Have you noticed that no one disses on the weatherman anymore? What happened?

The discipline of meteorology has had pretty good mathematical modeling capabilities for a while, but suffered from both a lack of sufficiently powerful computers and insufficient high quality real-time data to feed into the models. Over the past decades, computers have become much faster and we have built more observational capabilities (radar, ocean currents, etc.). So within a relatively short time, the discipline has begun producing more than respectable results.

So that begs the question – has the same thing happened with Economics? Get ready for a simple and clear answer, and enjoy it because this is the only time you will ever get one when talking about Econ. No. Hell no. Not only has it not, but it never, ever will happen. Why? It is partly that most of the weather guys are working together. But mostly it is because no one screws with the weather while someone is trying to predict it.

The most important (and annoying) phrase in Economics is “Ceteris Paribus”. It means ‘all other things equal.’ It is a way of making impossible real world problems into simplified theoretical ones by pretending everything that you don’t or can’t understand doesn’t exist. If you think that sounds farcical, then you get it. Ceteris Paribus strips out the immeasurable and the dynamic by locking all external things in place.

Think of the economy as a biosphere is the best way to get your mind around it. It is complex ecosystem consisting of many entities that compete, cooperate, and adapt. Information that is added into this system is quickly processed and used for decision making. The information is destroyed by its own discovery, because after it makes its way to participants, they add it into their decision making processes.

Say you are a caveman, and you discover a valley full of deliciously meaty defenseless creatures. This information has a very high value until you use it. When you show up at dinner with a bag full of barbecued tribbles, you are everyone’s best friend. But you are either going to tell someone else where you found them, or they will find them as well now that they know that Tribble Valley exists. The tribbles are eaten, and you are back to being the blingless 5th smallest caveman in your tribe. The key to exploiting information is to find a way to mine it while keeping it secret, and this is very difficult to do in an efficient, liquid, and open market. Ask a good fund manager what happens when they try to take a position in a small stock they like.

So Economics can’t predict anything useful in the real world, because all the decision makers have the same information as the predictor. But it is very good at illuminating the likely course of action from the point of view of players given a theoretical scenario. In other words, it is very good at what-ifs. This is not particularly useful for day-trading or even investing (although paradoxically it would be if no one else used it). But it is hugely useful if you can take the what-ifs and use them to manage risk and change law.

The end goal of the science of economics should be to inform public policy with the goal of creating a strategic space for all players that maximizes the public good. Economics is ultimately powerful as a tool of logic, showing us the optimal bridge to wherever we want to go. But choosing the location and agreeing on the starting point are non-trivial, and entirely up to us. Whoever ‘us’ is.