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Friday, September 28, 2012

21st Century Economics--The Fusion Approach

George Washington, the 1st president of the United States of America, died in 1799. Some reports say that doctors applied leeches to the father of our country as he suffered in his final days. Today, doctors don’t use medical “wisdom” from the 18th century to help their patients.

Lately, I have been hearing the same argument regarding economics. Scotsman Adam Smith published THE WEALTH OF NATIONS IN 1776 which most students of history of economic thought would say contains the first outline and spirited defense of the capitalistic system. Why do, many ask, economists and a few politicians hark back to early thinking developed in the 18th century or the industrial revolution of the 19th century? They get angry when anyone argues that government may be the problem and rarely the solution.  I agree with that up to a point. Yet, to me, certain economic truths have more to do with human nature than theory. Greed, envy, competition, technology and progress were with us in 1776 and remain with us today. They dominate human action, which is how noted Austrian economist Ludwig von Mises described economics.

For most of the 20th century, the Keynesians slugged it out with the Austrians and the Monetarists. John Maynard Keynes of Britain argued for government deficit spending during weak economic times. The Austrians approved of a laizzez faire approach and letting the economy heal itself by getting rid of malinvestment. The Monetarists said proper control of the money supply would control inflation. During the great depression all the way up to the Reagan Revolution of 1980, the Keynesians dominated.  Then the Monetarists and the Austrians, both ardent defenders of the free market began to take center stage. After the onset of The Great Recession, a Keynesian approach of massive government stimulus came roaring back in to our lives. Now countries across the world are printing vast quantities of money at different levels.  This is unprecedented in measured economic history. All I can say is that once you start printing it is very, very hard to stop

Through it all, no matter which school of thought dominated, all basically spun their theories on the concept that consumers acted rationally. Yet, by even cursory observation, we see people daily who are not making rational decisions. Some 20% of Americans are morbidly obese and studies of recent vintage indicate that such a sorry statistic could double over the next 20 years. Is putting your health in harm’s way a rational act?

Behavioral economics (see Media Realism, 3/22/11) is a new discipline that is a marriage between psychology and economics. It studies how people often use rules of thumb from their own experience or copy the behavior of others rather be the classic “economic man” and act rationally. Increasingly economists are saying that when people are irrational the government should intervene.

All this seems to be leading to what a few people have dubbed as “fusion economics.” There will be a pick and mix approach among the schools of economics. If people won’t act rationally, a series of paternalistic regulations will take hold to help people make decisions that are truly in the public’s long-term interest.  (For example, the risky mortgages that many took out in the first decade of this century would be prohibited. People would not lose homes in the future as a result of irrational decisions)

For two centuries, economists of nearly all stripes had boundless faith in the ability of markets to determine outcomes. Now, many of us are questioning whether markets always come up with the preferred outcome. Sounds great but who determines what THE preferred outcome is? The current crop of bureaucrats, perhaps? Fusion economics will not have a core philosophy. Taking one policy from the Keynesians, the next from the Monetarists and sprinkling in a bit of Austrian freedom seems like an odd mix to me although I do find Behavioral Economics fascinating.

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com

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