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Economic thought: 21st century
Origin of economic ideas in a historical context
We have been exploring the evolution of economics as a discipline/ field of study and how the work of economists shaped it over time. Since economics is a social science that seeks to explain the working of the world around us, economic thinking has also been shaped by the developments in the economy and society of the time. Our exploration underscores the key developments in each century including :
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18th century: Adam Smith and laissez faire
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19th century: classical microeconomics, classical macroeconomics and Marxist critique of classical economic thought
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20th century: Keynesian revolution and monetarist counter revolution
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21st century: developments in behavioural economics and the concept of a circular economy
We are now at the final step on our journey of exploring the development of economic thought over time and will focus on the current thinking in the 21st century.
Psychology and behavioural economics
Mainstream economics relies on the assumption of individuals being rational. A rational individual is self-interested and makes decisions to maximise (or optimise) his/her goals. Thus, consumers are expected to make decisions by evaluating their options to maximise their utility. Likewise, firms maximise their profits.
Looking back at your day, were all the decisions that you made today based on this unidimensional, self-serving and maximising mindset that economic theory assumes? Clearly not! There are a number of other aspects of human motivation and the human mind is neither as self-seeking nor as calculative as suggested by economic theory. A lot of developments in the twenty-first century in the field of economics have focused on this study of the not-so-rational economic agent. This distinction is sometimes underscored by labeling the rational individual homo economicus as opposed to its more real and imperfect version the homo sapiens.
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Behavioral economics attempts to enrich the existing body of work in economics by applying some of the principles of psychology and the growing understanding of the manner in which the brain works. While Adam Smith himself took notice of the flaws in rational decision-making, this part of his work was largely overlooked by mainstream economic theory until the twenty-first century.
Some of the notable contributions to the ever-growing field of behavioral economics are outlined below:
Herbert Simon, a Nobel Prize winning economist presented the concept of bounded rationality which highlights the limits on our rational behaviour due to factors such as cognitive capacity, availability of information and the time available for decision-making. Simon also argued that firms in the modern, complex business environment are not profit maximisers but profit satisficers ( i.e. seeking to earn a satisfactory level of profit that keeps stakeholders happy).
Amos Tversky and Daniel Kahneman considered how the manner in which the options are framed can determine which option economic agents will choose. This was presented in their work, Prospect Theory, published in 1979. As people are more scared of a loss than excited by a gain, framing an option as a potential loss rather than a potential gain could have more buy-in.
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Shefrin and Taylor in 1988 asserted that people prefer immediate gratification over saving (see video below). Rational behaviour, on the other hand, would suggest that they would save in order to maintain a certain level of consumption (and lifestyle) over their lifespan.
A number of economists notbaly Terrance Odean (1999) found that the volume of stock trading is much more than rational economic theory would predict. This was found to be due to the overconfidence of traders.
Cass Sunstein and Richard Thaler (2008) wrote a path-breaking book Nudge: Improving Decisions about Health, Wealth and Happiness. The main premise of 'nudge theory' is literally to nudge/encourage/prompt people to make decisions that are good for them. The concept has found widespread application in public policy ranging from ‘opt-out’ systems for organ donation (Spain) to encouraging people to eat healthy. In Thaler's words:
“if you want to get somebody to do something, make it easy. If you want to get people to eat healthier foods, then put healthier foods in the cafeteria, and make them easier to find, and make them taste better. So in every meeting I say, “Make it easy.”
Thaler was awarded the Nobel Prize in 2017.
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The full potential of behavioural economics is still in the process of being explored but it is clear that this nuanced understanding of human behaviour is definitely going to have a far-reaching impact not just on economic theory but also in the field of public policy.
Interdependence between the economy, society and environment: the circular economy
Before we start talking about the evolution of the circular economy models, perhaps you might want to take the following quiz that estimates your digital footprint and the number of earths (as in, the planet earth) it would take to sustain your lifestyle.
How do you feel about the results of the quiz? Can our planet continue to support our current patterns of consumption and resource usage? Which of our key concepts can you relate this situation to?
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It is exactly this feeling of alarm that led many individuals, academics and those in industry to think about a pattern of resource use that is more circular and not linear. In the latter, more conventional industrial models, the idea is to “take, produce, consume and dispose”. This results in a negative impact on the environment both in terms of the resulting pollution and environmental degradation caused by thoughtless disposal of waste and in terms of the overuse of natural resources.
Models of the circular economy are the result of an increased consciousness about this waste that gathered momentum in the last three decades of the twentieth century. According to the European Commision:
"In a circular economy, the value of products and materials is maintained for as long as possible. Waste and resource use are minimised, and when a product reaches the end of its life, it is used again to create further value."
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The focus is on being intentional about extending the life-cycle of products, minimising waste, eliminating the use of harmful inputs and focusing on renewable energy. This is achieved through careful engineering and design of production processes. Watch the following video to learn more about the circular economy.
The concept of the circular economy is an interdisciplinary one, challenging economics to interact with other disciplines. As a political and social movement it requires all of us to be responsible and mindful of our environmental footprint and to be proactive in promoting its underlying principles.
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Looking at the above infographics about the "take, produce, consume and dispose" economy and the circular economy what are some of the things that you notice?
Clues: think about the:
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Interrelationship between economy, society and environment
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Role of governments in ensuring responsible resource use
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Role of civic society in the circular economy
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Impact of 'circular economy' principles on the profitability of businesses
We will continue to explore these bigger concepts of efficiency, sustainability and choice in the rest of the course.