Economic methodology

Economic methodology refers to the way economists study the subject. As a social science, Economics tries to use scientific methods to explain how the economy at a microeconomic and macroeconomic level works. Because Economics is based on human behaviour its theories cannot be tested in the same way as a theory or idea can be in natural sciences such as Biology, Physics or Chemistry. Economists cannot use laboratories and control experiments.

Economists test their theories, laws and ideas by using empirical evidence. This is evidence gathered by observing how people behave and by using data. For example, we might expect a decrease in the price of Coca-Cola to lead to a rise in the quantity demanded for it. We can test this by looking at a situation where Coca-Cola reduced the price of its product and by looking at data from past price reductions by the company.

The role of positive economics

Positive economic statements are objective statements that can be proved true or false based on empirical evidence. Here are some examples of positive economic statements:

• ‘If interest rates are reduced economic growth rises’
• ‘As the price of a personal computer falls its quantity demanded will increase’
• ‘As the value of the US dollar falls US exports get cheaper’
• ‘Economic growth leads to rising income inequality’

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By analysing empirical evidence we generate information that can either support or refute a positive statement such as: ‘Economic growth leads to rising income inequality’. You could, for example, look at the relationship between Economic Growth in the South African economy in the last 10 years and changes in its income equality to support or refute the claim. Evidence is important in supporting claims and it can also be used to refute claims if the evidence does not support them.

Positive economics can also be looked at in terms of logic and reasoning. It is logical to assume that reducing the price of the Apple iPad Pro from $1000 to $800 will increase its quantity demanded because more people can afford to buy the product which supports the claim: ‘As the price of a personal computer falls its quantity demanded increases’.

Hypotheses, models and theories are central to the scientific method used in the study of Economics. For the claim: ‘If interest rates are reduced economic growth rises’, an economist might hypothesise that reducing interest rates will increase consumer spending, which will increase aggregate demand, thus leading to increased economic growth. The circular flow of income model can be used to support this hypothesis, along with the theory that there is a negative relationship between interest rates and consumption spending.

Ceteris paribus is an important part of the scientific method used in Economics. Ceteris paribus means other factors are held constant when looking at the relationship between variables in Economics. For the claim ‘as the value of the US dollar falls US exports get cheaper’, we can assume, for example, that US inflation does not make its exports more expensive. Economics is a very complex subject because so many variables are changing at the same time, meaning it is difficult to analyse how one variable affects another.

The role of normative economics

Normative economic statements are value judgements that cannot be proved to be true or false based on empirical evidence. They often form the basis of economic policymaking.

Here are some examples of normative economic statements:

• ‘Healthcare should be provided by the state’
• ‘Professional footballers are paid too much’
• ‘The governments ought to reduce interest rates to combat a recession’
• ‘Increased consumption of alcohol is bad for society’.

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The claim: ‘Professional footballers are paid too much’ can be based on the view that someone who plays a professional sport should not be paid as much as they are. Is, for example, Lionel Messi worth the $127 million a year he earns. The economic policy view might be to put high taxes on people who earn such high salaries.

Economic thought - The origin of economic ideas

Adam Smith

In the 18^th century, the Scottish Economist and Philosopher Adam Smith wrote the book, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). One of the key themes of the book was to argue that the over-regulated and controlled Economic systems that existed at the time hindered economic development and prevented the gains from economic activity from benefiting the wider population. Smith believed that allowing a free and unhindered exchange of goods and services (laissez-faire markets), both within countries and through international trade, benefited buyers and sellers and increase incomes throughout the population.

Classical economic thought

Classical economics developed from Adam Smith’s theories into the 19th century. Classical microeconomics considered areas such as utility theory, which is based on the principle that individuals consume goods and services to maximise satisfaction from their consumption. An example of classical microeconomics comes from Say’s Law. The law developed by Jean Baptiste Say states that producing goods and services creates demand. As people are paid to produce something, income is created, which creates demand for other goods and services. If a factory opens in a town it will pay people to work there and those workers will be able to buy goods and services in the town.

Marxism

In the second half of the 19th century, the German Economist and Philosopher Karl Marx became increasingly influential as a critic of capitalism. He saw rich industrialists gaining wealth and power at the expense of ordinary workers and believed that workers would rise up to overthrow capitalism and replace it with socialism.

John Maynard Keynes

Keynes is seen as one of the most important figures in the development of macroeconomics. Keynes saw a more influential role for governments in the economy than classical economists did. Much of his work was shaped by the Great Depression of the 1930s. Keynes’ book, The General Theory of Employment, Interest and Money was published in 1936. Keynes' work was very influential on macroeconomic policymaking by western governments in the second half of the 20^th century.

Monetarism

Macroeconomic thought was dominated by Monetarism in the 1970s. The theory was based on the principle that the supply of money in the economy was the key determinant of economic growth and inflation. A central figure in monetarism was the Nobel Prize-winning economist, Milton Friedman. He advocated the use of interest rates by governments to control the money supply and the rate of inflation. Monetarists believed that by using monetary policy to maintain low inflation a country would achieve the long-run economic growth needed for sustained improvements in prosperity.

Behavioural economics

Behavioural economics gives increasing importance to psychology and human behaviour in economic decision-making.  The economist, Richard Thaler, won the Nobel prize for Economics in 2017 for his work on Nudge Theory which looked at how indirect suggestion and positive reinforcement can make individuals act in a certain way. A supermarket, for example, might put confectionery at the checkout to encourage people to buy it. Behavioural economics is different to classical economic thinking which is based on rational economic decision-making. Behavioural economics allows for irrational behaviour and tries to understand why people might behave in this way.

Economic thought and sustainability

Doughnut Economics

The Oxford University economist, Kate Raworth developed the model called Doughnut Economics. Her theory is based on a model of sustainable economic development. It can be viewed in pictorial form as a series of concentric rings. Raworth believes economic activity aims to meet the needs of everyone in the world within the sustainable resource limits (ecological ceiling) of the planet.

Raworth's view is that governments should move away from being overly focused on Economic growth because of its environmental consequences (renewable) and be more concerned with how existing resources can maximise the welfare of everyone (redistributive) now and in the future. The centre of the 'doughnut' (social foundation) represents the number of people in society who do not have access to the necessities of life. 

Equity and equality

Zambian-born economist, Dambisa Moyo started with an undergraduate degree in Chemistry, and went on to do an MBA at the American University in Washington DC, an MPA at Harvard University and a DPhil in Economics at Oxford University. She is on the board of directors for the Chevron Corporation and the 3M Company. She has also worked for the World Bank and Goldman Sachs.

Dambisa Moyo is a high-profile economist who regularly features on business news channels, TedX lectures and even major television shows such as Real Time with Bill Maher. She has written a number of best-selling books in Economics and the Political Economy. Her most recent book, Edge of Chaos: Why Democracy Is Failing to Deliver Economic Growth – and How to Fix It spent some time on the New York Times bestseller list.

One of the central themes of Edge of Chaos is how population growth, rising income inequality, commodity scarcity and technological development are undermining economic welfare and social cohesion in so many countries in the world. Moyo believes a growing underclass of people in the world economy is stuck in low-paid employment and does not have sufficient political representation. She believes this underclass is a risk to economic, political and social stability in countries across the world.

Moyo believes the solution to these problems lies in developing a more long-term strategic approach to economic and political decision-making where the private sector and government sector work in partnership to manage and fund long-term solutions to issues such as low labour productivity, static incomes and inequity.

Two interesting areas of focus in Edge of Chaos are, firstly, the need to reward a nation’s politicians more highly and then make them more accountable for their decisions. The hope is that this will make them take a more long-term view in their decision-making. Secondly, Moyo believes that moving more resources globally towards education would be the single most important policy to solving the problems facing the world's poor.