The recent announcement by George Soros of the Initiative for New Economic Thinking is exciting for the future of economic science. This is because ?it holds the possibility of giving new impetus to the exploration of alternative strands of thought that would provide better insights into how our complex economic systems function, and perhaps also to the search for policies that might avert a recurrence of the recent calamity?, to quote Nobel Laureate Joseph Stiglitz.
The economic and financial crisis that ravaged both developed and developing countries has necessitated reflection on where economics as a science has gone wrong. The previous two decades had witnessed relative economic stability, and there was evidence of increasing global prosperity. There appeared to be no reason, therefore, to examine either the basic approach or the premises of economics at a fundamental level, except to the extent of refining and improving on the existing models. Events as they unfolded during the recent crisis have, however, occasioned the need to re-examine the basic postulates of economic science.
Microeconomic theory is based on the postulates of decision-making by rational individuals trying to maximise utility in a world of competitive markets and complete information. Economists have worked on showing that markets may not be competitive. Nor is information always symmetric. Also, as recent experience with asset bubbles has demonstrated, human beings do not always act on the basis of reason alone. Emotions can and do play an important part in decision-making.
Developments in behavioural economics in recent years have integrated valuable insights from psychology into the field of economic science. These include, inter alia, those concerning human judgement, decision-making under uncertainty and inter-temporal choice. While these have enriched the science of economics, they have evidently not gone far enough.
Neuro-economics has utilised new technologies to study brain activity while performing different tasks in the economic domain. It has tried to identify brain areas that control economic actions. However, the initial enthusiasm with respect to ?lighting up the brain? has still to be followed up
How must economic theory evolve so as to enable a better understanding of how individuals and economies function, and thereby enable us to ?nudge? the relevant actors with a view to ?stumbling? towards happiness, greater economic prosperity and stability?
Traditional economics has focused on reason and rationality in decision-making, whereas psychology has emphasised the primacy of emotions. Neuro-economics needs to study the relative forces that determine the final outcome when reason and emotion compete in the decision-making process within the individual human brain. This understanding, combined with influencing the relevant variables through appropriate incentives and disincentives, can enable greater stability of markets and institutions in the future. This would go a long way in averting economic and financial crises of the sort witnessed recently.
The nascent field of neuro-economics could actually be poised to take economic science to its next level, by providing fresh insights into the decision-making processes in the human brain. The crucial link remaining to be put into place is the direction of future research. It is here that this column attempts to shed light. Similarly, at the macro-economic level, the neoclassical school had begun to wish away the cycles of booms and busts. Unfortunately, these wishes were belied. Perhaps neuro-economics can teach us something in this field as well.
There is still another field in which economic science must progress if it is to contribute to a better understanding of economic and social progress.
Classical and neo-classical economics have been based on the premise of rational individuals working to protect their own ?self- interest? and creating an optimal outcome through the invisible hand of the market. This self-interest has varied according to the cultural context. It is a function of the values and beliefs of the concerned societies and individuals making up the societies. Mental constructs of individuals?including perceptions, beliefs and value systems?are based on their own and others? experiences. And human learning is the sum total of experiences over past generations. This cumulative learning is embodied in the culture of a society, which not only determines the preferences, beliefs and value systems of the society but also contributes to the process of change of these variables over time.
Economic and social change is a process that has been shaped by the combined interplay of individual players and the larger whole. Economic science of the future will, therefore, need to focus on a better understanding of individual mental constructs within the larger scaffolding provided by a society and its culture, and on better knowledge of culture and its impact on economic outcomes.
Since mental constructs evolve over time?and are based on the combined operation of genes and the environment?increasing knowledge from neuro-science about the human mind and the human brain, and from social and political sciences, can have exciting ramifications for economics, economic stability and economic progress.
Integration of these insights into existing economic theory can enable economic science to make better predictions and enable the more ?reasonable? world idealised by Plato. These are exciting directions for the future of economics?thousands of flowers can bloom in valleys of the future as we await a world with more rational and reasonable outcomes, which are foreseeable and predictable.
The writer is a civil servant. Views are personal