August 30, 2011

GDP Measures a Lot of Things

Suppose we look at an economy. Let's take an example that is close to home - the economy of Israel (that would be close to my home).
So GDP Measures everything that the Israeli economy produces in one year - the IDF, the Israeli education system, the bread baked in bakeries (including pita bread since this IS the middle east), and also the refined diamonds that Israel exports that are consumed say in Belgium.
If the Israeli economy were to produce the exact same products in 2011 as it did in 2010, only 5% more of each, than we could comfortably say that the Israeli GDP grew 5%, but what if for example everything else stayed the same, and only diamond production went up by 50%?
Now if Diamond production is 10% of the Israeli economy, we would still be inclined to say that GDP went up by 5%, but this completely changes the picture. For starters, most of the diamonds produced (refined) in Israel are not consumed in it, and for seconds, only a small group of Israelis has enjoyed this growth, and it might not 'trickle down' to the rest of the Israeli population.
So here we have seen two scenarios of '5% Growth' that are not that similar. In the next few weeks I will show how for different 'products' GDP and changes in GDP mean different things.

August 24, 2011

One Equation Is Often Too Little

Quite often when I sit down to discuss Science with my literary friends, the subject turns to Quantum Mechanics. It seems that many people think that 'Quantum Mechanics disproves Science', or that 'Quantum Mechanics proves that everything is in the eyes of the beholder'.
I'll be the first person to admit that quantum mechanics is in many ways non-intuitive, difficult, and yes it does attribute some role to the 'observer' (in most interpretations).
However, Quantum Mechanics is very much a scientific theory in that it fits our observations of nature. In fact, Quantum Mechanics is so powerful, that it can deduce from one number (the Atomic Number) any number of physical qualities (such as easiness of chemical bonding, Melting Temperature, Color, and Density). So in the case of Quantum Mechanics, one equation, or one observed variable (Atomic Number) predicts many other things.
But this is not a column about Physics, but rather, it is about Economics, and Economic Growth in particular. The Wikipedia article about Economic Growth is not a bad place to start. Basically it says that Modern Economics has three Growth Theories: The Solow Model, Endogenous Growth, and Integrated Growth.
Here is the Solow Model:

It goes like this: there is Economic Growth as long as the amount of Capital per Worker increases. Endogenous and integrated Growth try to explain why there is ongoing Growth in the modern world, and why there was less of it, more than about 250 years ago.
But, I think all of these models are flawed. They are flawed because any Modern Economy (and any non-modern economy as well) is way too complex to fit into a single number (such as Capital per Worker).
So in the next few weeks I'll try to show why one number (in Economics, as opposed to Quantum Mechanics) is not enough.

August 17, 2011

I'm Back: Economic Musing Number One

First and foremost, I'm back from Hungary. Before now, I've been to Hungary just once, in 1987, back in the Communist Era. Needless to say, there were quite a few changes, mostly economic changes, between then and now. More about this in later musings.
Second of all, despite the title of this post, I don't intend to number all of the Economics Musings, and like I said in the previous post, I don't intend to write only Economics Musings. Nuff said.
Let's get down to business.
The main reason that I think that modern Economics is broken is that it's not a predictive science. Let's make this clearer: since at least the time of Isaac Newton, Physics has been a predictive science. We know with fantastic accuracy where hundreds of objects in our Solar System are going to be in the next few centuries (never mind the wonderful experiment of dropping your pen and checking whether and when it hits the ground!).
We can say the same thing about the predictive ability of Genetics since the times of Gregor Mendel. However, this is definitely not the case with economics!
Arguably the most important economic variable is GDP. Now, if one were to predict say the GDP in Israel in the next couple of years, one would probably not be very wrong, if one were to use the current GDP. So the GDP changes from year to year, but not by much, only a few percent. Needless to say that this adds up over the years, and if one were to predict the GDP of Israel 50 years from now, one would be in serious trouble!
But that's not all. The change in GDP is called Economic Growth, and it is also very important (the question of whether the Economy is in a recession or in a boom is a question of Economic Growth). Now Israel's growth was supposed to be something like 5% this year. Yesterday we found out that in the second quarter it was only 3.3% (on a yearly basis). Anyone care to guess what the 2011 GDP growth in Israel is going to be? (when more than half the year is over! this is predicting the present, not the future!)
Like I said yesterday we found out the the earlier prediction might be 50% off, and will almost certainly be at least 20% off. This is normal in Economics, hence my saying that current economics is not a predictive science.
Economists faced with this truth are saying to me things like: 'Look, Economics is hard, so many things effect GDP Growth, it's hard to predict!" They are right of course.
All I'm claiming is that given how many things effect GDP, the tools (equations, models) used by economists are too simple, and too simplistic.
More about this next week.

August 2, 2011

Coming up next

Despite the dismal record of this blog with regards to future posts in general, and series of future posts in particular, I'd like to declare, hmmm, well, a series of future posts.
You see, for many years I've been a student of Economics (Formally from late 1992 to mid 2003, but informally also ever since). In all those years I've been thinking that there is something broken in Economics.
I don't mean that it's a little thing that is broken, I mean that the whole framework of modern Economics is seriously bent.
Now, if I'm right, this is potentially a huge deal, because unlike other Social Sciences, Economics is used in our everyday decision making process, both on the private level and on the public level.
Thing is this, it's hard to enunciate even what a 'good' Economic Theory would look like, because like I said earlier, the whole framework is bent.
So I propose a series of 'Economic Musings', to be published here in the next few months. Hopefully by the time it is done, it'll all be clearer to all, myself included.
However, next week, I'm in Hungary, after many years of not taking a vacation abroad, so expect the first 'Economic Musing' to be here in two weeks time.
Also, I bet current affairs, and my wavering interest, will sometimes require posts about other subjects, so stay tuned...