In my new book Economics: The User's Guide, I aim to show the reader how to think, not what to think, about the economy. There are a few important things to keep in mind when you are 'using' economics.
Cui bono?
Economics is a political argument. It is not - and can never be - a science; there are no objective truths in economics that can be established independently of political, and frequently moral, judgments. Therefore, when faced with an economic argument, you must ask the age-old question 'Cui bono?' (Who benefits?), first made famous by the Roman statesman and orator Marcus Tullius Cicero.
Sometimes it is easy to see the political nature of an economic argument because it is based on questionable assumptions that blatantly favour certain groups. The trickle-down argument, for example, crucially depends on the assumption that, when given a bigger slice of national output, the rich will use it to increase investments - an assumption that has not been borne out by reality.
In other situations, an argument may favour certain people unintentionally. For example, the dominant Neoclassical school of economics uses the Pareto criterion to judge social improvement. It may seem not to favour anyone, as it says a change is a social improvement only when it makes some people better off without making anyone worse off and thus does not allow even a single person to be trampled on by the rest of society. Yet it implicitly favours those who benefit more from the status quo, as the criterion allows them to prevent any change to the status quo that hurts them.
Political and ethical judgments are present even in ostensibly value-free exercises, such as defining the boundaries of the market. Deciding what belongs in the domain of the market is an intensely political exercise. Once you can drag something (say, water) into the domain of the market, you can apply the 'one-dollar-one-vote' rule to decisions surrounding it, making it easier for the rich to influence the outcome.
Conversely, if you can take something (say, child labour) out of the domain of the market, it becomes impossible to influence its use with the power of money.
Saying that economics is a political argument does not mean that 'anything goes'. Some theories are better than others, depending on the situation at hand. But it does mean that you should never believe any economist who claims to offer 'scientific', value-free analysis.
Don't become a 'man with a hammer'
There isn't just one right way of 'doing' economics, despite what most economists tell you. Though the Neoclassical approach has been the dominant one in recent decades, there are at least nine different schools of economics, each with its strengths and weaknesses.
The economic reality is complex and cannot be fully analysed with just one theory. The various economic theories conceptualize basic economic units differently (e.g., individuals v. classes), focus on different things (e.g., macro-economy v. micro-economy), ask different questions (e.g., how to maximize the efficiency with which we use given resources v. how to increase our abilities to produce those resources in the long run) and try to answer them using different analytical tools (e.g., full rationality v. bounded rationality).
As the saying goes, 'he who has a hammer sees everything as a nail'. If you approach a problem from a particular theoretical point of view, you will end up asking only certain questions and answering them in particular ways. You might be lucky, and the problem you are facing might be a 'nail' for which your 'hammer' is the most appropriate tool. But, more often than not, you will need to have an array of tools available to you.
You are bound to have your favourite theory. There is nothing wrong with using one or two more than others - we all do. But please don't be a man (or a woman) with a hammer - still less someone unaware that there are other tools available. To extend the analogy, use a Swiss army knife instead, with different tools for different tasks.
The economy is much bigger than the market
Much of economics these days is about the market. Most economists today subscribe to the Neoclassical school, which sees the economy as a web of exchange relationships - individuals buy various things from many companies and sell their labour services to one of them, while companies buy and sell from many individuals and other companies.
But the economy should not be equated with the market. The market is only one of many different ways of organising the economy - indeed, it accounts for only a small part of the modern economy. Many economic activities are organised through internal directives within firms, while the government has influences - and even commands - over large sections of the economy. Governments - and increasingly international economic organisations like the WTO - also draw the boundaries of markets while setting rules of conduct in them. Herbert Simon, the founder of the Behaviouralist school, once estimated that only about 20% of economic activities in the US are organised through the market.
The focus on the market has made most economists neglect vast areas of our economic life, with significant negative consequences for our well-being. The neglect of production at the expense of exchange has made policy-makers in some countries overly complacent about the decline of their manufacturing industries. The view of individuals as consumers, rather than producers, has led to the neglect of issues like the quality of work (e.g., how interesting it is, how safe it is, how stressful it is, and even how oppressive it is) and work-life balance. The disregard of these aspects of economic life partly explains why most people in the rich countries don't feel more fulfilled despite consuming the greatest ever amounts of material goods and services.
The economy is much bigger than the market. We will not be able to build a good economy - nor a good society - unless we look at the vast expanse beyond the market.
This is an extract from Ha-Joon Chang's latest book, Economics: The User's Guide, which is available in stores now