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FSU Jena The Economic Approach to the Social Sciences – Scope and Limitations Prof. Dr. Michael Fritsch Winter 2016 / 2017 (December 1, 7, 8, 14, 15, 2016) Fritsch: Approaches to Economic Science Winter 2016 / 2017 1 Contact Chair of Business Dynamics, Innovation, and Economic Change Carl-Zeiss-St. 3, 07743 Jena Secretary: Frau Anja Ladig, Room 5.10 Tel.: (036 41) 9 - 4 32 30, [email protected] Prof. Dr. Michael Fritsch Room 5.12, Tel.: – 43 220 [email protected] Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 2 1 FSU Jena Literature A number of sources is available in the Approaches to Economic Science Library http://www.uiw.uni-jena.de/index.php/sonstiges/approaches-toeconomic-sciences-library of the Chair for Business Dynamics, Innovation, and Economic Change (user-id and password necessary). Use of the Entrepreneurship Library is only permitted in connection with the courses. Fritsch: Approaches to Economic Science Winter 2016 / 2017 3 Topics 1. The economic approach in the social sciences 2. Economic approaches to explain social behavior 3. Limits of the economic approach 3.1 How to identify irrational behavior ? The debate about „merit“ goods 3.2 When is exchange ‘involuntary’ ? 3.3 Moral limits to the market 3.4 Methodological individualism and ‘systemic’ phenomena 3.5 Instrumentalism: Do assumption need to be empirically “true” ? 4. The economic theory of constitutions 5. An overview of critique of the economic approach―How relevant ? Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 4 2 FSU Jena General literature on the topic Becker, Gary S. (1976): The economic approach to human behavior. Chicago: University of Chicago Press. Frey, Bruno S. (1992): Economics as a science of human behaviour: towards a new social science paradigm. Boston: Kluwer. Kirchgässner, Gebhard (2008): Homo Oeconomicus: the economic model of individual behavior and its applications in economics and other social sciences. New York: Springer. MacKenzie, Richard B. and Gordon Tullock (1978): The new world of economics: Explorations into human experience. Homewood (Ill.): Irvin. Noteboom, Bart (2014): How Markets Work and Fail, and What to Make of Them. Cheltenham: Elgar. Sandel, Michael J. (2013): Market Reasoning as Moral Reasoning: Why Economists Should Re-engage with Political Philosophy. Journal of Economic Perspectives, 27(4), 121140. Fritsch: Approaches to Economic Science Winter 2016 / 2017 5 1. The economic approach in the social sciences The economic approach tries to explain human behavior based on four principles: Methodological individualism, Choices are based on the evaluation of alternatives oriented at individual utility, Rationality, Action is regarded as voluntary exchange. Further assumption: Preferences are relatively constant over time. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 6 3 FSU Jena Methodological individualism: Pro and cons Basic assumption: The individual is the starting point of any explanation, not the group, state, nation, etc ! Opposite position: Methodological collectivism, popular particular in large parts of sociology and political science. States that the collective body has a specific identity that can not completely be explained by the characteristics of its members; it is a separate ontological phenomenon. “The whole is more than the sum of its parts!” (Aristotle, Metaphysics) However, methodological individualism says nothing about the rule of aggregation; this may be adding up, multiplication, etc. and should particularly account for the relationships between actors. Against methodological collectivism: Who is entitled to express the preferences of the group as a whole? May justify dictatorship! Fritsch: Approaches to Economic Science Winter 2016 / 2017 7 Methodological individualism vs. collectivism Conclusions Synthesis: Given that both approaches cannot explain social phenomena completely, they imply different research strategies: Methodological individualism: From the inside, starting with individual action (“skeleton”-approach). Example: Academic medicine. Methodological collectivism: From the outside, starting with the behavior of groups or societies (“corset”-approach). Example: Holistic medicine (e.g., Ayurveda, homeopathy). Q: Is macroeconomics economic theory? Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 8 4 FSU Jena Evaluation of action by the consequences for individual utility I Basic approach: Actions are evaluated on the basis of their consequences, they have no value as such (intrinsic value). The criterion for judging the consequences is their effect on individual utility (pain and pleasure). → Utilitarianism → “Greatest happiness principle” (Jeremy Bentham). Problem I: Do actions have no value as such? (e.g., procedural value such as democratic vs. dictatorial decisions) Problem II: What determines utility? Economic approach: Subjective utility, i.e. the individual knows best what is good for him (sovereignty of the individual). Hence, the utility of an individual can not be judged from the outside, i.e. by other actors. Fritsch: Approaches to Economic Science Winter 2016 / 2017 9 Evaluation of action by the consequences for individual utility II What determines utility (continued) pecuniary based vs. non-pecuniary based utility ethical values (J. St. Mill, 1863: “It is better to be a human being dissatisfied than a pig satisfied, better to be Socrates dissatisfied than a fool satisfied”). → Rule utilitarianism? other actor’s utility → altruism as utility maximization? → pareto-optimal redistribution. Important implication of the concept of subjective utility: Different levels of utility can not be compared in terms of cardinal values. We may only know that someone’s utility has remained unchanged or if he/she is better off or worse off. We can not say anything about the amount of utility change. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 10 5 FSU Jena Evaluation of action by the consequences for individual utility III Implications of the concept of subjective utility (continued) Utility levels of different individuals can not be compared → Pareto-criterion! Redistribution can not be justified on the basis of economic theory (exception: pareto-optimal redistribution). Fritsch: Approaches to Economic Science Winter 2016 / 2017 11 Rational behavior Basic assumption: Actors chose the alternative that they appreciate most, i.e. which has the highest utility for them (rational choice behavior). Forms of rationality: Objective rationality: Actors have perfect information about all relevant alternatives and maximize their individual utility. Subjective rationality: Actors may have incomplete or even incorrect information and maximize their individual utility. Bounded rationality: Actors may have incomplete or even incorrect information and chose the alternative that matches their aspiration level. They act as utility “satisficers”, not “maximizers”. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 12 6 FSU Jena Features of bounded rationality Gathering and processing information causes effort (cost). Actors contrast the expected benefit of additional information with the respective cost and stop searching for additional information if they do not expect a net-benefit. Since actors stop to search for further alternatives or to apply more sophisticated evaluation methods they may chose a suboptimal alternative. Hence, which alternative is chosen may heavily depend on the order in which they are evaluated. Fritsch: Approaches to Economic Science Winter 2016 / 2017 13 Human action as voluntary exchange Basic assumption: Human action is an exchange relationship (“There is no such thing as a free lunch!”). Hence, individuals will establish and maintain relationships if this appears rewarding to them. It is of crucial importance that this exchange is voluntary. Exchange does not need to occur simultaneously. Actors may just expect to attain a reward at some time in the future. (Example: Insurance contract). Tipping ? Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 14 7 FSU Jena Pareto Criterion and the Pareto Region Utility A E I D IV (Pareto region) F C II III Utility B Fritsch: Approaches to Economic Science Winter 2016 / 2017 15 An important implication: The ‚liberal prejudice‘ Voluntary exchange relationships between rational egoists lead to an increase of social welfare. Restriction of individual exchange relationships need to be justified ! Main economic argument: Market failure. Examples: Free trade Mergers & Acquisitions Regulation of shop opening hours Policy restrictions to entry Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 16 8 FSU Jena Methodological individualism, political individualism, and anarchism Methodological individualism: An approach to empirical analysis and theorizing. Taking the individual as a starting point. Explanation! Normative individualism: Emphasizes individual freedom. Wants to protect individual freedom and autonomy against obligations imposed by social institutions (such as the state or religious morality). Recommendation! Anarchism: Denies the legitimacy of the state and its right to interfere with individual behavior. Extreme form of political liberalism. Fritsch: Approaches to Economic Science Winter 2016 / 2017 17 2. Economic approaches to explain social behavior Microeconomic theory, particularly the model of perfect competition. Macroeconomic theory Theory of bureaucracy Economic theory of politics / public choice Choice of constitutional rules … The economic approach is able to explain a considerable part of human behavior in the economic sphere as well as in other fields. It is particularly well suited if relationships are ‘impersonal’ and / or anonymous. But even some parts of the ’personal’ relationship (e.g. trust) may be explained on the basis of economic theory. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 18 9 FSU Jena Applications of the economic approach outside the sphere of economics in the narrow sense Literature Kirchgässner, Gebhard (2008): Homo Oeconomicus: the economic model of individual behavior and its applications in economics and other social sciences. New York: Springer. MacKenzie, Richard B. and Gordon Tullock (1978): The new world of economics: Explorations into human experience. Homewood (Ill.): Irvin. Fritsch: Approaches to Economic Science Winter 2016 / 2017 19 Examples Rule breaking Criminal activity Spouse selection Child production Sexual behavior Riots and panic … Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 20 10 FSU Jena 3. Limits of the economic approach 3.1 How to identify irrational behavior? The debate about „merit“ goods 3.2 When is exchange ‘involuntary’? 3.3 Moral limits of the market 3.4 Methodological individualism and ‘systemic’ phenomena − Macroeconomics − Innovation systems Fritsch: Approaches to Economic Science Winter 2016 / 2017 21 3.1 How to identify irrational behavior? The debate about „merit“ goods – Literature Musgrave, Richard A. (2008): Merit Goods. The New Palgrave, Vol. 5, London: McMillan, 579-582. Sunstein, Cass and Richard Thaler (2009): Nudge: Improving Decisions about Health, Wealth, and Happiness. Revised and expanded edition, New York: Penguin. Thaler, Richard and Cass Sunstein (2003): Libertarian Paternalism. American Economic Review, 93, Papers and Proceedings, 175-179. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 22 11 FSU Jena How to identify irrational behavior? The debate about „merit“ goods Basic idea: There may be cases in which it is desirable that government ‘corrects’ individual decisions and preferences (Richard Musgrave). Definitions: Merit good: Actors do not consume “enough” of a good. Subsidize the respective good or service in order to increase consumption. Examples: Education, school lunch, health services, cultural events (opera houses), … . Demerit good (“sin good”): Actors consume too much of a certain good or service. Put a special tax on that good or regulate supply of the good in order to reduce consumption. Examples: Cigarettes, alcoholic beverages, ‘hard’ drugs, regulation of opening hours for shops and bars, regulation of prostitution, … . Fritsch: Approaches to Economic Science Winter 2016 / 2017 23 Alternative justifications for correcting individual preferences and behavior External effects public goods. Insufficient information provide more information. Misleading advertizing Inhibit misleading advertizing, provide correct information. Non-rational or irrational behavior ??? Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 24 12 FSU Jena Types of non-rationality Behavioral anomalies: Behavior violates basic assumptions of decision theory. Differences between existing and perceived opportunities. Irrational behavior. Fritsch: Approaches to Economic Science Winter 2016 / 2017 25 Non-rationality: Behavioral anomalies Examples: Actors do not maximize their expected utility. Information is processed selectively. Decisions are considerably influenced by the way the problem is presented. Risk-attitude depends on the type of decision to be made. Behavior deviates from certain assumptions of decision theory. Behavior may appear rational if these assumptions are modified. Relevance for public intervention questionable! Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 26 13 FSU Jena Non-rationality: Differences between existing and perceived opportunities Differences between existing and perceived opportunities lead to a systematic underestimation or overestimation of possibilities and events. Decisions may not be optimal. Examples: Actors do not have an insurance because they underestimate the probability of a damage. Over-optimism when founding a business, marrying, … . Resignation of unemployed persons. Strategic avoidance of certain situations. Strategic excessive ambitions. Relevant for the justification of public intervention? Fritsch: Approaches to Economic Science Winter 2016 / 2017 27 Non-rationality: Irrational behavior Definition: Individual behavior is irrational if it violates the own interests. Examples: Consumption of addictive drugs. Self-inflicted injury, suicide. Contradictory behavior. Problem: Identification of irrational behavior requires knowledge of individual preferences! Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 28 14 FSU Jena Justification of public intervention based on „nonrational behavior“ of actors? Approach to the problem: A correction of individual decisions is justified if the respective actor agrees to the intervention ex-post (“Educational dictatorship”). Problems: One can never know for sure ex-ante that the respective actors will indeed agree ex-post.. How does the change of preferences come about? (by “brainwashing”?) Justification of public intervention based on non-rationality is not in accordance with the economic approach ! However: There may exist a problem that requires public intervention even if we are currently unable to explain it on the basis of the economic approach !!! Fritsch: Approaches to Economic Science Winter 2016 / 2017 29 Libertarian paternalism: Nudges Nudges: An attempt to direct human behavior by means of a conscious design of a decision framework, i.e., ‘gentle’ persuasion towards certain kinds of desired behavior (‚libertarian paternalism‘). Goal: Induce rational decisions and support self control. Examples: Sales-promotional placement of healthy food in cafeterias and supermarkets; unfavorable placement for unhealthy food. Shock pictures and health warnings on cigarette packets. Obligatory consultation for certain financial transactions. Supply of contracts that include self-commitment (e.g., saving plans, retirement savings, in case of addiction). Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 30 15 FSU Jena Nudges – The Problems Who decides? In what way legitimized? Even ‘gentle’ paternalism may reduce individual freedom (Who pays for respective political campaigns? …). Paternalistic guidance may reduce a person’s capability of autonomous problem solving. Fritsch: Approaches to Economic Science Winter 2016 / 2017 31 3.2 When is exchange ‘involuntary’ ? The concept of ‘coercion‘: In which cases does coercion cause involuntary exchange? Being held at gunpoint Blackmail Wants to keep the job / avoid unemployment Poverty, hunger, sickness The concept of ‘reasonable alternatives’ / freedom of choice Market concentration / market power ‘Unreasonable’ behavior (e.g., price cartels, dumping) ‘Unfair’ behavior (e.g., false promises and cheating) Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 32 16 FSU Jena 3.3 Moral limits of the market Literature Sandel, Michael J. (2012): What Money Can't Buy: The Moral Limits of Markets. London: Allen Lane. Sandel, Michael J. (2013): Market Reasoning as Moral Reasoning: Why Economists Should Re-engage with Political Philosophy. Journal of Economic Perspectives, 27(4), 121-140. Waldfogel, Joel (1993): The Deadweight Loss of Christmas. American Economic Review, 83, 1328-1336. See also http://scholar.harvard.edu/sandel/home http://www.justiceharvard.org/ http://www.justiceharvard.org/ Fritsch: Approaches to Economic Science Winter 2016 / 2017 33 When economic exchange may be immoral or harmful Economics is a value-neutral (amoral) science. It can hardly help to decide which goods should be allocated by the market and which goods should be allocated by nonmarket principles. Examples for market transactions that might be regarded immoral: sex for sale, pregnancy for pay, selling citizenship (by the state, by citizens), selling a kidney or a child for adoption, selling votes in political elections, paying to kill animals (e.g., shoot a walrus), a market for human blood, … . Trading certain goods on markets may lead to the erosion of morals in a society. There are moral limits to market allocation! Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 34 17 FSU Jena Waldfogel, Joel (1993): The Deadweight Loss of Christmas. American Economic Review, 83, 13281336. Argument: Presents in kind instead of money lead to a welfare loss because preferences of people are not perfectly met. Recipients would be better off with money transfers. Stigma of cash giving is an irrational obstacle to utility and should be overcome. Why should behavior based on norms that reach beyond a simple market calculus be irrational? Gifts instead of cash giving may reflect norms such as attentiveness and thoughtfulness. Be careful with normative conclusions! Fritsch: Approaches to Economic Science Winter 2016 / 2017 35 3.4 Methodological individualism and ‘systemic’ phenomena Three examples: Macroeconomics Innovation systems and networks Systems of entrepreneurship Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 36 18 FSU Jena Methodological individualism and ‘systemic’ phenomena: Macroeconomics Why ‘macroeconomics‘? Mass phenomena Coordination problems (e.g. investment overshooting, pork cycle) Interdependencies between markets (e.g., the money market and the commodity markets) Macro phenomena (e.g. inflation, gross domestic product, business cycles). Macroeconomics for description and forecasts Macroeconomics as a basis for policy? Fritsch: Approaches to Economic Science Winter 2016 / 2017 37 Innovation systems Literature Edquist, Charles (2006): Systems of Innovation – Perspectives and Challenges. In Jan Fagerberg, David C. Mowery and Richard R. Nelson (Eds): The Oxford Handbook of Innovation. Oxford: Oxford University Press (Chapter 7). Metcalfe, Stan (1995): The Economic Foundations of Technology Policy: Equilibrium and Evolutionary Perspectives. In: Paul Stoneman (ed.): Handbook of the Economics of Innovation and Technological Change. Oxford: Blackwell, 409-512. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 38 19 FSU Jena Methodological individualism and ‚systemic‘ phenomena: Innovation systems Basic recognition: Innovation activity is characterized by a pronounced division of labor between different organizations and actors. It would be inappropriate to focus analysis solely on innovation activities of certain individuals or organizations. Holistic perspective: the system, not only the individual actor!? The efficiency of an innovation system depends to a substantial degree on the interaction (= division of innovative labor) of its components as well as on its integration into external knowledge flows. This interaction particularly comprises: competition, market exchanges, cooperative relationship, networks (“embedded markets“). interactive learning. Fritsch: Approaches to Economic Science Winter 2016 / 2017 39 Innovation system: a definition “A .. system of innovation is that set of distinct institutions which jointly and individually contributes to the development and diffusion of new technologies and which provides the framework within which governments form and implement policies to influence the innovation process. As such it is a system of interconnected institutions to create, store and transfer the knowledge, skills and artifacts which define new technologies." (Metcalfe, 1995, 462f). Principle constituents of an innovation system are: actors, relationships of actors, the institutional framework, the knowledge base. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 40 20 FSU Jena Innovation networks Jena Halle BSW Ingenieurbüro Schott Tridelta inocermi c CZ AM FH Merseburg IPHT SL HITK FhG FSU Jenapharm IMB Siemens LM Jenoptik MPG HITK AI GESO HKI TITK MUEG KataLeuna MLU Jenaer Glas SynTec Agfa LeunaWerke FEW Chemtec Leuna Paraffinwerk HKI RMH TITK Krupp Buna Sow Leuna OvGU TUC Sanierungsges. Wolfen Inofex MD Haack TITV Fritsch: Approaches to Economic Science Winter 2016 / 2017 41 Systems of entrepreneurship Literature Qian, Haifeng, Zoltan J. Acs and Roger R. Stough (2013): Regional systems of entrepreneurship: the nexus of human capital, knowledge and new firm formation. Journal of Economic Geography, 13, 559–587. Szerb, Laszlo A., Zoltan J. Acs and Erkko Autio (2013): Entrepreneurship and Policy: The National System of Entrepreneurship in the European Union and in Its Member Countries. Entrepreneurship Research Journal, 3, 13, 9-34. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 42 21 FSU Jena A systems perspective on entrepreneurship Systems of entrepreneurship are “those economic, social, institutional and all other important factors that interactively influence the creation, discovery and exploitation of entrepreneurial opportunities.” (Qian, Acs and Stough, 2013, 561f.). “The National System of Entrepreneurship is the dynamic, institutionally embedded interaction between entrepreneurial attitudes, abilities, and aspirations, by individuals, which drives the allocation of resources through the creation and operation of new ventures.” (Szerb, Acs and Autio, 2013, 13). Fritsch: Approaches to Economic Science Winter 2016 / 2017 43 The entrepreneurship system Source: Lundström & Stevenson (2005, 270). Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 44 22 FSU Jena Entrepreneurial profile of three European regions Source: Szerb et al. (2014) Fritsch: Approaches to Economic Science Winter 2016 / 2017 45 3.5 Instrumentalism: Do assumptions need to be empirically “true”? Basic literature Friedman, Milton (1953): The Methodology of Positive Economics. In Milton Friedman (ed.): Essays in Positive Economics, Chicago: University of Chicago Press. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 46 23 FSU Jena The structure of alternative uses of hypotheses Assumption I. Explanation: II. Prediction: Effect If then it follows ? known known ? Fritsch: Approaches to Economic Science Winter 2016 / 2017 47 Instrumentalism – Basic statements I. The quality of theories has to be judged by their practical value. II. The practical value of theories is their ability to yield valid predictions about phenomena not yet observed. III. The empirical truth of assumptions is irrelevant as far as a theory has sufficient predictive power. Assumptions of a good theory need to be unrealistic (abstract, simplified). Abstract and empirically wrong „as if“ assumptions can yield correct predictions. Examples: Profit maximizing behavior, theory of masterly billiard playing. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 48 24 FSU Jena Criticism against instrumentalism Instrumentalism neglects explanations. Not only predictions but explanations can be the purpose of science. Instrumentalism implies no procedure how to attain better theories (e.g., by having assumptions that are empirically true). A theory based on wrong assumptions does not provide an adequate basis for political intervention. Fritsch: Approaches to Economic Science Winter 2016 / 2017 49 4. The economic theory of constitutions Literature Original sources: Buchanan, James M. and Gordon Tullock (1962): The Calculus of Consent – Logical Foundation of Constitutional Democracy. Ann Arbor: University of Michigan Press. Rawls, John (1973): A Theory of Justice. Cambridge, Mass. : Belknap Press. Rawls, John (1974): Some Reasons for the Maximin Criterion. American Economic Review, 64, 141-152. Textbook: Mueller, Dennis C. (2003): Public Choice III. Cambridge (UK): Cambridge University Press. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 50 25 FSU Jena Constitutional consent about decision rules (Buchanan & Tullock) Costs Expected external costs + Expected decisions making costs = Interdependence costs Interdependence cost Expected external costs 1% Expected decision making costs GKmin 100% Gkmin represents the optimal decision rule. Required share of voters Fritsch: Approaches to Economic Science Winter 2016 / 2017 51 Basic principles of a fair society according to John Rawls I. “Each person has the same indefeasible claim to a fully adequate scheme of equal basic liberties, which scheme is compatible with the same scheme of liberties for all.” II. "Social and economic inequalities are to be arranged so that they are both: (a) to the greatest benefit of the least advantaged, consistent with the just savings principle (Difference principle), and (b) attached to offices and positions open to all under conditions of fair equality of opportunity.“ Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 52 26 FSU Jena Economics and ethics: John Rawls’ difference principle Nutzen Utility AA D ID E IE G 45° Utility BB Nutzen Fritsch: Approaches to Economic Science Winter 2016 / 2017 53 The evolutionary approach to a theory of constitutions Criticizes social contract theory. Main argument: Real constitutions do not emerge out of thin air but they develop step by step. Explains a factual constitution as the result of a darwinistic selection procedure according to a „survival of the fittest“, i.e., the better constitutions survive and are chosen (→ Systems competition) The ‘better‘ constitutions replace the ‘inferior’ constitutions or rules. Over time, the quality of constitutions increases. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 54 27 FSU Jena 5. An overview of critique of the economic approach―How relevant ? Literature Noteboom, Bart (2014): How Markets Work and Fail, and What to Make of Them. Cheltenham: Elgar. Fritsch: Approaches to Economic Science Winter 2016 / 2017 55 An overview of critique of the economic approach―How relevant ? Economic models are irrelevant because they are based on unrealistic assumptions. Actors’ choices are not completely rational. Actors do not make decisions completely autonomous and independent. They are strongly influenced by other actors and their social environment. People are not entirely egoistic but have also ‘social’ preferences and values. The economic approach ignores and cannot explain such social preferences and values The concept of ‘homo economicus’ ignores important issues such as personal identity, self-esteem (dignity), respect, sympathy (friendship, love and hate), trust etc. that matter in establishing and maintaining exchange relationships. Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 56 28 FSU Jena Critique of the economic approach―How relevant ? (continued) The economic approach ignores moral limits to exchanges. The economic approach largely fails in analyzing the role of formal and informal institutions for economic development. The economic approach fails to appropriately deal with complex social phenomena such as ‘systemic’ effects. Fritsch: Approaches to Economic Science Winter 2016 / 2017 57 Thank you for your attention ! Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 58 29 FSU Jena Simple Questions 1. What is the basic difference between methodological individualism and methodological collectivism? 2. Explain why the economic approach implies a ‘liberal prejudice’? 3. Individual A has 30 units of a good, individual B has only 20 units. After a redistribution of 5 units from A to B both would have 25 units each. Is the society better off due to this redistribution? 4. Explain how the economic approach can be applied for explaining the behavior of politicians? What is the basic assumption that is made in this respect concerning the utility of politicians? 5. People have imperfect information that may lead to suboptimal choices. Is this kind of behavior irrational? Fritsch: Approaches to Economic Science Winter 2016 / 2017 59 Simple Questions (continued) 6. Does the economic approach imply political individualism? 7. Empirical research has found convincing evidence that smoking may kill. Therefore, the majority of politicians want to forbid smoking. Can this be justified under the economic approach? 8. Explain moral limits of markets using two examples! 9. Explain the assumption of a ‘veil of ignorance’! Why are individual preferences more homogeneous behind this veil? 10. Do assumptions of economic theory need to be empirically true? Fritsch: Approaches to Economic Science Winter 2016 / 2017 Fritsch: Approaches to Economic Science Winter 2016 / 2017 60 30