Is 95% of economics common sense, in the sense that an explanation could be given to a non-economist that they then thought to be very plausible? In respect of financial economics, the core of this is asset pricing theory (Capital Asset Pricing Model, Option Pricing Model, etc). I'm very sceptical that an explanation of the CAPM given to a non-economist would be considered plausible, if only because one first has to define several phenomenon that are not part of everyday experience, including an expectation and a covariance. I'm even more sceptical in respect of the OPM, which must be preceded by an explanation of cumulative standard normal density, natural logarithms and continuous compounding.
I agree 95% might be too high Martin, and certainly so if laypeople were to understand the quantitative output of economic models and regressions. But if just a basic intuition suffices, and if that may require a range of explanation and analogies and time taken to discuss and reflect on them, then perhaps 95% may be ok?
Eg, in financial economics people tell me most people can't do NPV calculations. I reply but most people jump on mortgage calculators to figure out how much they can borrow and what homes they can afford (if any), and they can intuitively get their heads around NPV/annuities as a result. On risk pooling, there are the sayings like 'don't put all your eggs in one basket'. And on real options, there's the intuition around 'keeping your powder dry'. Like Māori whakataukī these sayings are prompts into stories and discussions of what they really mean, and people can coordinate around shared understandings to maybe be roughly right most of the time.
Hi Chris, I agree that some aspects of financial economics are "common sense" and I highlighted examples to the contrary only in order to contest the proposition that 95% of economics was so. In respect of whether "not putting all your eggs in one basket" is the common sense equivalent to the Markowitz Portfolio Model, the latter does far more than merely conclude that diversification is good; it identifies what sort of diversification is best (across assets with low correlations in their returns) and it identifies the optimal weights on the possible assets for a given level of expected return. In this area, the common sense about eggs captures far less than 95% of the Markowitz Model. In respect of "keeping your powder dry", I understand that saying originates from the need for soldiers in the musket era to literally keep their gunpowder dry or it wouldn't ignite when required (the modern equivalent to gunpowder is not exposed to the elements). The military counterpart to Real Options Theory would instead seem to be "don't shoot too early". However, as with eggs in baskets, Real Options Theory does far more than conclude one shouldn't shoot early; it identifies situations where you should instead invest now (shoot now) rather than wait. Furthermore, in determining whether to invest now or wait, the model uses a recursive process requiring knowledge of future possible scenarios, and certain features of these future possibilities determines whether to invest now or wait. So, again, the common sense idea of not shooting too early captures far less than 95% of the model.
Twice I've lost my fully drafted reply... this website is glitchy. So I'll keep this super brief sorry:
I agree for expert stuff; that's why post-grad degree equivalent is required that 95% of people couldn't possibly attain.
But I think the original point was that most people are capable of engaging economists most of the time when economists are giving advice on trade-offs -- so they should make an effort. And Dave's point is the economists' expert advice can make all the difference sometimes.
"Science" can be sub-categorised into natural science and social science. The point that Ha-Joon Chang is trying to make is that economics is social science, not a mechanistic pseudo-natural science. The politics is important, the history is important, the debate over value adding v value extracting is important. 'Political economy' is a more encompassing and relevant descriptor than 'economics'.
ps - value adding v value extraction is well explored in The Value of Everything by Mariana Muzzacato
pps - wouldn't 'common sense' include considering the viability of fuel distribution companies when halving the price of fuel is proposed?
ppps - taking economic geography papers and economics papers at Massey in the early 1990s, I found that economic geography provided a more comprehensive analysis/descriptor/explanation of the neoliberal changes introduced by the Fourth Labour government.
Glad to see another economics writer on Substack! I remember reading Chang's books a while ago - happy to see a commentary on them.
I'd actually say that, in a way, all of economics is common sense - but the issue is which 'common sense' is correct. The issue is that every mechanism or finding can be explained logically, but only one of the versions is true (or occurs most often). For example, I wrote about student debt forgiveness - one can have many logical narratives explaining whether this is beneficial or not. But some narratives for example do not take into account that debt impacts people's choices of jobs, which car result in sub-optimal job choices, meaning the state ends up with less tax revenue. So student debt forgiveness may potentially increase revenues for the state! But if we ignore this part, then another narrative can sound logical.
Another example that has been very important recently is does wage growth cause higher inflation. Again, we can logically argue why this could be true, but data and empirical analysis points in one direction.
Personally, I think all of economics can be explained clearly (my goal with Nominal News), which I think makes economics seems as if anything can be true. But we have done already substantial amounts of research that really place several guardrails on what are feasible answers on certain questions. The problem regarding public communication is that the people/economists often commenting in public often use old research, focus only on their own narratives and rarely, if ever, state the underlying assumptions behind their comments. This makes it seems like economists are wrong, but really, there are many economists (the silent majority) that would vehemently disagree with this person. We just don't get to see them.
On the "common sense" point, I was reminded of the section on 'The Tyranny of Common Sense' in Diane Coyle's enjoyable 2002 book, 'Sex, Drugs & Economics'. She says (p197), and I like her view as against Chang's, that "A lot of economic truths simply don't tally with common sense or conventional wisdom. The economist David Henderson has labeled this sort of incorrect common sense "do-it-yourself economics". He has collected a list of such DIY notions, all wrong, and also prominent exponents ranging from business leaders to senior judges, the president of the World Bank to the archbishop of Canterbury". And she concludes (p226) in her section on 'Ten Rules of Economic Thinking', that "Where common sense and economics conflict, common sense is wrong".
Is 95% of economics common sense, in the sense that an explanation could be given to a non-economist that they then thought to be very plausible? In respect of financial economics, the core of this is asset pricing theory (Capital Asset Pricing Model, Option Pricing Model, etc). I'm very sceptical that an explanation of the CAPM given to a non-economist would be considered plausible, if only because one first has to define several phenomenon that are not part of everyday experience, including an expectation and a covariance. I'm even more sceptical in respect of the OPM, which must be preceded by an explanation of cumulative standard normal density, natural logarithms and continuous compounding.
Kia ora Martin, Dave.
First, thanks Dave for an interesting post.
I agree 95% might be too high Martin, and certainly so if laypeople were to understand the quantitative output of economic models and regressions. But if just a basic intuition suffices, and if that may require a range of explanation and analogies and time taken to discuss and reflect on them, then perhaps 95% may be ok?
Eg, in financial economics people tell me most people can't do NPV calculations. I reply but most people jump on mortgage calculators to figure out how much they can borrow and what homes they can afford (if any), and they can intuitively get their heads around NPV/annuities as a result. On risk pooling, there are the sayings like 'don't put all your eggs in one basket'. And on real options, there's the intuition around 'keeping your powder dry'. Like Māori whakataukī these sayings are prompts into stories and discussions of what they really mean, and people can coordinate around shared understandings to maybe be roughly right most of the time.
Chris
Hi Chris, I agree that some aspects of financial economics are "common sense" and I highlighted examples to the contrary only in order to contest the proposition that 95% of economics was so. In respect of whether "not putting all your eggs in one basket" is the common sense equivalent to the Markowitz Portfolio Model, the latter does far more than merely conclude that diversification is good; it identifies what sort of diversification is best (across assets with low correlations in their returns) and it identifies the optimal weights on the possible assets for a given level of expected return. In this area, the common sense about eggs captures far less than 95% of the Markowitz Model. In respect of "keeping your powder dry", I understand that saying originates from the need for soldiers in the musket era to literally keep their gunpowder dry or it wouldn't ignite when required (the modern equivalent to gunpowder is not exposed to the elements). The military counterpart to Real Options Theory would instead seem to be "don't shoot too early". However, as with eggs in baskets, Real Options Theory does far more than conclude one shouldn't shoot early; it identifies situations where you should instead invest now (shoot now) rather than wait. Furthermore, in determining whether to invest now or wait, the model uses a recursive process requiring knowledge of future possible scenarios, and certain features of these future possibilities determines whether to invest now or wait. So, again, the common sense idea of not shooting too early captures far less than 95% of the model.
Twice I've lost my fully drafted reply... this website is glitchy. So I'll keep this super brief sorry:
I agree for expert stuff; that's why post-grad degree equivalent is required that 95% of people couldn't possibly attain.
But I think the original point was that most people are capable of engaging economists most of the time when economists are giving advice on trade-offs -- so they should make an effort. And Dave's point is the economists' expert advice can make all the difference sometimes.
"Science" can be sub-categorised into natural science and social science. The point that Ha-Joon Chang is trying to make is that economics is social science, not a mechanistic pseudo-natural science. The politics is important, the history is important, the debate over value adding v value extracting is important. 'Political economy' is a more encompassing and relevant descriptor than 'economics'.
ps - value adding v value extraction is well explored in The Value of Everything by Mariana Muzzacato
pps - wouldn't 'common sense' include considering the viability of fuel distribution companies when halving the price of fuel is proposed?
ppps - taking economic geography papers and economics papers at Massey in the early 1990s, I found that economic geography provided a more comprehensive analysis/descriptor/explanation of the neoliberal changes introduced by the Fourth Labour government.
Glad to see another economics writer on Substack! I remember reading Chang's books a while ago - happy to see a commentary on them.
I'd actually say that, in a way, all of economics is common sense - but the issue is which 'common sense' is correct. The issue is that every mechanism or finding can be explained logically, but only one of the versions is true (or occurs most often). For example, I wrote about student debt forgiveness - one can have many logical narratives explaining whether this is beneficial or not. But some narratives for example do not take into account that debt impacts people's choices of jobs, which car result in sub-optimal job choices, meaning the state ends up with less tax revenue. So student debt forgiveness may potentially increase revenues for the state! But if we ignore this part, then another narrative can sound logical.
Another example that has been very important recently is does wage growth cause higher inflation. Again, we can logically argue why this could be true, but data and empirical analysis points in one direction.
Personally, I think all of economics can be explained clearly (my goal with Nominal News), which I think makes economics seems as if anything can be true. But we have done already substantial amounts of research that really place several guardrails on what are feasible answers on certain questions. The problem regarding public communication is that the people/economists often commenting in public often use old research, focus only on their own narratives and rarely, if ever, state the underlying assumptions behind their comments. This makes it seems like economists are wrong, but really, there are many economists (the silent majority) that would vehemently disagree with this person. We just don't get to see them.
On the "common sense" point, I was reminded of the section on 'The Tyranny of Common Sense' in Diane Coyle's enjoyable 2002 book, 'Sex, Drugs & Economics'. She says (p197), and I like her view as against Chang's, that "A lot of economic truths simply don't tally with common sense or conventional wisdom. The economist David Henderson has labeled this sort of incorrect common sense "do-it-yourself economics". He has collected a list of such DIY notions, all wrong, and also prominent exponents ranging from business leaders to senior judges, the president of the World Bank to the archbishop of Canterbury". And she concludes (p226) in her section on 'Ten Rules of Economic Thinking', that "Where common sense and economics conflict, common sense is wrong".