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The Indian Constitution and Human Dignity: for Economists

The field of law and economics is a glamorous one with economists such as Ronald Coase, Gary Becker and Richard Posner. It was Coase who provided the inspiration to law and economics through his introduction of ‘transaction cost economics.’ And Becker was the one who extended the domain of economics to virtually any social phenomena. Issues such as law, crime, marriage, family, etc came to be studied by economists. Although, the tools used never varied. It was the same old microeconomic baggage of neoclassical economics. Suddenly, neoclassical economics started feeling successful all over again. Their theory of value and pricing started explaining various social and cultural processes in the economy. However, this post is not a commentary on law and economics that is practised. For an excellent commentary on its origins and methodology, see the article by William Davies ‘Economics and the ‘nonsense’ of law: the case of the Chicago antitrust revolution’ in Economy and Society published in 2010.

The content of this post certainly falls under the label of law and economics. However, this post discusses certain aspects of the Constitution of India in the the light of economic policies undertaken-that of liberalization. The quotations in this post are from Dr. Durga Das Basu’s Introduction to the Constitution of India, reprinted in December 2009.

Economic Justice

The banishment of poverty, not by expropriation of those who have, but by the multiplication of the national wealth and resources and an equitable distribution thereof amongst all who contribute towards its production, is the aim of the State envisaged by the Directive Principles. Economic democracy will be installed in our sub-continent to the extent that this goal is reached. In short, economic justice aims at establishing economic democracy and a ‘Welfare State’.

The idea of economic justice is to make equality of status meaningful and life worth living at its best removing inequality of opportunity and of status-social, economic and political.

That is, an increase in growth rate is seen as the way to banish poverty. This principle is certainly based on the idea that growth trickles down. As has been witnessed in India, all that liberalization has achieved is ‘jobless growth’. Hence, the need for policy documents to shout for ‘inclusive growth’.

Now, all those who contribute to wealth by being producers are supposed to be compensated. It is on this class, that the burden of development falls. For, they do not have the adequate social and economic voice to demand for ‘just distribution’.

Can India claim social justice just by making opportunities equal’ Equal opportunities perform their function only in an already just and equitable society, and not in countries where inequality of income and wealth is so skewed. Thus, an active intervention is necessary at the level of production as well as distribution of GDP.

Nehru’s idea of Socialism is that ‘every individual in the State should have equal opportunity for progress.’ However, this idea cannot hold any water until the institutions in the State are examined- judiciary, executive, military, private enterprise, unorganised sector, etc. For instance, some groups of people are exploited as producers, where they are paid less than minimum wages. Therefore, as a consumer, they get exploited as well. This then passes on to their access to health, schooling, sanitation, housing, and so on.

Individual Liberty

The Preamble, therefore, says that the State, in India, will assure the dignity of the Individual. ‘All citizens men and women equally, have the right to an dequate means of livelihood, just and humane conditions of work, and a decent standard of life and full enjoyment of leisure and social and cultural opportunities.’

When economists and policy makers talk of ‘inclusive growth’, it is the dignity of the individual which is at stake. Often, India’s characteristics such as high reliance on agriculture, a large percentage of unorganised sector, immobility of labour and the like are labelled as detrimental to India’s growth and development. One cannot help but ask: Whose growth’ Such perceptions by the academia are largely a result of the manner in which human beings figure in micro and macro economics. If you take a moment to think about it, you will realise that poor people-who are a heterogeneous group- is absent from our theoretical edifice. Why’ Who are we analysing’ And to discuss poverty, we have created a sub-discipline called ‘development economics’.

In any case, human dignity appears to be of lesser importance than the computation of growth rates using yearly and quarterly data. We are satisfied to decipher whether stock market exhibits volatility or not’ Or whether market A is co-integrated with market Z. Does this satisfaction come from the fact that stock market data is easily available’ What about the farmers, the child labourers, the migrant labourers who are forced to leave their place and family, of street vendors, and all the others who actually engage in production’

Until dignity of human life features implicitly or explicitly in economics, it will continue to be a lifeless endeavour. Sadly enough, we are taught economics is the study of choice’ Whose choices’ Those who have the ability to choose’ It is time we discarded such economics and re-visited economists such as Adam Smith, Joan Robinson, Amit Bhaduri, and others whose works show a concern for humans.

Utility in Microeconomics: Outdated’

This post clarifies the concept of a utility function, which occupies a very significant position in neoclassical microeconomics. Advances in neuroeconomics and related fields of behavioural economics is constantly challenging the conventional assumptions of microeconomics. This post takes up one such insight by Stephen B Hanauer which was published in Nature in March 2008.

A utility function can be understood in the following way:

U=f(x,y,z) where U is the utility derived from the consumption of x, y and/or z. Alternatively, a utility function transforms combinations of various goods into a single value. Note that x,y and z refer to ‘quantities’ of goods/services consumed.

Suppose, consumer A has the following utility function: U=x+y+z; arbitrary values of x,y and z would result in the following values of U.

x y z U
0 0 0 0
1 0 0 1
10 10 0 20
6 6 8 20
0 10 10 20
10 10 10 30

That is, microeconomics teaches us that the utility of the consumer is determined by the quantity of goods consumed. An common assumption is that ‘more is better’, which implies that the consumption of more goods gives the consumer more utility. The point to be noted is that microeconomic theory teaches us that utility is strictly a function of quantities. The question posed in this post is whether utility is ‘only’ a function of quantities. What happens if utility is also a function of prices’ At this juncture, we need to recollect the objective of utility functions. From the utility function, we derive indifference curves and marginal utilities. Utility or use value of the good or service forms the basis of the demand function, which along with the supply function determines the value/price of a commodity or service. Thus, the use value was employed so as to arrive at the exchange value/relative price of the commodity.

What happens if utility (or experienced pleasantness) is influenced by ‘changing properties of commodities, such as prices” That is, can neoclassical microeconomics accomodate the following utility function:

U=f(x,y,Px,Py)

And research in behavioural economics and related areas suggest that prices exert a significant influence on utility and hence on choice and demand. However, if we accept such a utility function, it can no longer be used to explain exchange values/relative prices. Another implication is that prices are no longer determined by the interaction of demand and supply. And the statement that ‘consumer is the king’ no longer holds. Also, producers can adjust prices in such a way as to affect consumers’ utilities. We know that high prices are often associated with better quality and hence higher utility.

x y Px Py U
0 0 10 10 0
10 10 10 10 200
10 10 5 10 150
10 10 4 4 80

The above table can be explained by the following utility function: U=x.Px + y.Py

In this case, a higher price gives more utility to the individual. The maximum utility is when x=y=10 and Px=Py=10.

The other extreme case is when high prices are detested by the individual. For instance, consumers with low incomes will get more utility from consuming goods which are priced less. Their utility function could be represented as follows: U=x.-Px + y.-Py

In which case, the consumers utilities based on the previous values of x,y,Px and Py will be 0, -200, -150 and -80. And the consumer’s utility is maximum when he/she consumes x=y=10 when Px=Py=4.

Empirical evidence suggests that utility is equally influenced by prices of commodities as well. Does this threaten the core of neoclassical microeconomics’ This is problematic because neoclassical economics assumes the following to be given: 1) tastes and preferences of individuals, 2) endowments of goods and 3) constant technology. It if from these ‘givens’ that prices and quantities (demanded and supplied) are arrived at through the mechanism of demand and supply/competition/market forces. How can we include the recent findings pertaining to consumer utility and satisfaction in a consistent manner’

‘Update

The link to the reference was embedded in the authors name. However, because of the comment by Dr. Thomas Alexander, the reference is prrovided below. Also,I acknowledge him for bringing this article to my notice.

Hanauer, S (2008), ‘Experienced Pleasantness,’ Editorial, Nature Reviews Gastroenterology and Hepatology 5, 119 (1 March 2008).

On Financial Markets: The Problematic Assumptions

More than half of the dissertations and theses in India are on financial markets. Various aspects such as pricing of options, efficiency of markets, volatility of markets, its impact on the real sector, futures markets, effect of foreign trade, etc are analysed. Financial markets refer to the stock market, the derivatives market, the commodity markets, etc. For our purposes, we will take into account only the stock/share market as it is the one that is most well-understood in comparison to the rest. This blog post echoes a lot of my concerns with the way financial markets are analysed, and also indicates some of the broader concerns about econometric work in general. I have been greatly motivated and moved by Benoit Mandelbrot’s and Richard Hudson’s book The (Mis)Behaviour of Markets in writing this post. All quotations in this post are from their book.

On attending several pre-submission, post-submission, work-in-progress and viva-voce seminars, I have often wondered about economists fascination with the ‘normality assumption’. We assume that price changes follow a normal distribution, that is, outliers (both small and large) do not significantly affect the average/expected value. That is, standard theories of finance ‘assume the easier, mild form of randomness. Overwhelming evidence shows markets are far wilder, and scarier, than that.’ Now, in natural sciences, this is a common enough assumption. Is there any empirical evidence supporting the use of such a distribution in economics, mainly the analysis of changes in prices and quantities’ One wonders. In fact, it is this distribution which underlies the most commonly used tool in regression ‘ the method of least squares. Most studies (academic and corporate) measure volatility using variance or standard deviation of the normally distributed variables. As Mandelbrot asks, ‘is this the only way to look at the world”

Apart from the normality assumption, orthodox financial theory makes the following assumptions. This list is directly based on Mandelbrot’s book. (1) People are rational and aim only to get rich. (2) All investors are alike and they are price-takers, not makers. (3) Price change is practically continuous. (4) Price changes follow a Brownian motion, that is each price change appears independently from the last, the price changes are statistically stationary and that the price changes are normally distributed.

Assumptions (1) and (2) need no discussion, owing to their obvious falsity. Now it is assumption (3) that allows the use of continuous and differential functions; whereas, the reality is that ‘prices do jump, both trivially and significantly’ and that discontinuity is an ‘essential ingredient of the market.’ The meaning of independent price changes is that, price at t+1 is not dependent on price at t. In other words, prices have no memory. An example from tossing a fair coin will illustrate this better. Suppose a fair coin is tossed once, we get a head. The outcome of the next toss is not based on the outcome of the previous one. Again, how true this is of stock markets or of prices is questionable. How can such an assumption cope up with ‘expectations’ of investors’ The statistical stationarity of price changes implies that the process generating the price changes stays the same over time.

Very often, in research, we do not have the time to question these assumption; not only that, these assumptions function as received wisdom. However, as Mandelbrot comments, ‘They work around, rather than build from and explain, the contradictory evidence’ because ‘It gives a comforting impression of precision and competence.’ For, a high kurtosis (the measure of how closely the data fits the bell curve) has been found in the prices of commodities, stocks and currencies.

To conclude, how does one as a researcher overcome such problematic/unreal/easy assumptions’ Is this what academic ‘discipline’ means’ Or are we to learn adequate mathematics and statistics so that we can find a way around it’ Or do we cooperate and seek help from mathematicians and statisticians’ Mandelbrot has developed tools and concepts such as ‘fractal analysis’ and ‘long memory’ which can aid economics, which is inherently not a study of normally distributed variables.