economics: Microeconomics wins ‘macro vs micro’ conversation

For most of its existence as a modern field of study since the 18th century, economics – the filter this newspaper bears in its title – has fared reasonably well at explaining consumer and producer behaviour. It explained why buyers choose the products they do, how firms produce them to maximise profit, and how markets discover the most efficient prices. This changed with the Great Depression, when aggregate variables came into play that needed a better understanding than an assumption that markets return to equilibrium after shocks. Thus came into existence macroeconomics, the most dismal aspect of the dismal science. Economics has since diversified into quite a few other branches, such as those employing statistics and psychology, but most of its disrepute originates from its failure to predict financial crises.

‘Macro’ by its very nature – dealing with GDP, employment, inflation and other important but soporific matters and parameters – is headline-grabbing stuff. Governments come into play here, as do international relations. Yet, macro eludes the scientific method of testing hypotheses with repeated experiments: one can’t conceivably wreck an economy to establish the effects of a shock. Instead, macroeconomists can only back-test their models against data that may be of questionable provenance. This makes prediction of the next stock market crash forever embarrassingly less exact than the return of Halley’s Comet.

Microeconomics, the reputable part of the endeavour, suffers from fewer limitations to controlled parameter experiments and delivers less equivocal insights. The explosion of commerce in the modern world owes itself in no small measure to predicting actions by the smallest economic agents: humans. Here, too, heroic assumptions are made, the foremost being that human beings are rational and information is free. The crisis in economic modelling arises from aggregating billions of micro truths into one macro truth. Models are improving, so are quantitative capabilities, and the qualitative judgements that drive macro policy will become more refined. The spread (a subject of macro) of banking (micro explains how the industry works) reduces poverty and improves labour productivity. The two branches of economics are inextricably bound. But with microeconomics having its foot far more visible in the game than macro with its invisible hand and other limbs, this paper will put the micro horse before the macro cart.