Economics Explained: Assumptions and Economic Models

An assumption, in the context of economic models, refers to a simplifying belief or proposition about the behaviour of individuals, firms, or the overall economic system. These assumptions are necessary because economic models attempt to capture the complexity of real-world phenomena and make them more understandable and analysable.

Assumptions serve as building blocks for economic models, providing a foundation upon which the analysis can be conducted. They help economists create a framework that abstracts away unnecessary details and focuses on key variables and relationships of interest. By making assumptions, economists can isolate specific factors and explore their impact on economic outcomes.

For example, when constructing a model to analyse consumer behaviour, economists may assume that individuals are rational decision-makers who seek to maximise their personal satisfaction or utility. While this assumption may not accurately capture every aspect of real-world consumer behaviour, it simplifies the decision-making process and allows economists to predict how individuals might respond to changes in prices, incomes, or other factors.

Similarly, in the study of market dynamics, economists often assume perfect competition, which assumes a large number of buyers and sellers, identical products, and perfect information. Although perfect competition is rarely found in reality, this assumption enables economists to study market equilibrium, price determination, and the effects of various policy interventions in a more manageable way.

Assumptions in economic models also often employ the ceteris paribus principle, which means "all else equal." This principle assumes that while analysing the relationship between two variables, all other factors remain constant. This allows economists to focus on the specific relationship of interest without getting entangled in the complexities of simultaneous changes in multiple factors.

It is important to note that assumptions are simplifications and abstractions, and they may not always perfectly reflect reality. However, they serve a crucial role in economic modelling by making the analysis feasible, highlighting key relationships, and providing initial insights into economic behaviour and outcomes. While assumptions are necessary, it is also important for economists to continuously test and refine them based on empirical evidence to improve the accuracy and reliability of economic models.

Assumptions and simplifications in mathematical economic models can introduce potential biases and limitations in several ways:

1. Inaccurate representation of reality: Economic models are abstractions that aim to simplify the complex real world. However, by making assumptions and simplifications, models may fail to capture the full complexity and nuances of economic phenomena. These simplifications can lead to a mismatch between the model's assumptions and the actual behaviour of individuals, firms, or markets, potentially introducing biases in the model's predictions.

2. Omission of relevant variables: Economic models often involve simplifications that exclude certain variables or factors that may be important in real-world situations. This exclusion can limit the model's ability to provide a comprehensive understanding of the economic system under study. The omission of relevant variables can result in biased or incomplete analysis, as important drivers of economic behaviour or outcomes may be neglected.

3. Assumptions about individual behaviour: Many economic models rely on assumptions about the behaviour of individuals, such as the assumption of rationality or self-interest. However, these assumptions may not always hold true in reality. Individuals may exhibit bounded rationality, have imperfect information, or behave altruistically, which can deviate from the assumptions made in economic models. Such deviations can lead to biased predictions or inaccurate representations of real-world phenomena.

4. Simplified market structures: Economic models often assume simplified market structures, such as perfect competition, monopoly, or oligopoly. While these assumptions provide a useful framework for analysis, they may not reflect the complexities of actual markets. Real-world markets can exhibit various degrees of competition, market power, and imperfect information, which can introduce biases when using simplified market structures in economic models.

5. Linear relationships: Many economic models assume linear relationships between variables for simplicity and tractability. However, in reality, relationships between variables may be nonlinear or exhibit diminishing returns. Assuming linearity can introduce biases in predictions or policy recommendations, as it may not accurately capture the actual dynamics and interactions among variables.

6. Limited scope of analysis: Economic models often focus on specific aspects or sectors of the economy, neglecting interdependencies and feedback effects. This limited scope can introduce biases by overlooking broader systemic effects or failing to capture the full consequences of policy interventions. It is important to recognise that economic systems are complex and interconnected, and simplifications in models can restrict the understanding of these interconnections.

To mitigate these limitations and biases, economists employ various techniques, such as sensitivity analysis, robustness checks, and empirical validation, to test the assumptions and evaluate the robustness of model predictions. Additionally, economists strive to develop more realistic and nuanced models by incorporating more accurate assumptions, relaxing unrealistic assumptions, or adopting alternative modelling approaches to address the limitations and biases introduced by simplifications.

Principles of Economics Translated by Yoram Bauman

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Give Us Kerala Model Over Gujarat Model, Any Day

Ramachandra Guha in NDTV

When, towards the end of the first decade of the present century, Narendra Modi began speaking frequently about something he called the 'Gujarat Model', it was the second time a state of the Indian Union had that grand, self-promoting, suffix added to its name. The first was Kerala. The origins of the term 'Kerala Model' go back to a study done in the 1970s by economists associated with the Centre for Development Studies in Thiruvananthapuram. This showed that when it came to indices of population (as in declining birth rates), education (as in remarkably high literacy for women) and health (as in lower infant mortality and higher life expectancy), this small state in a desperately poor country had done as well - and sometimes better - than parts of Europe and North America.

Boosted to begin with by economists and demographers, Kerala soon came in for praise from sociologists and political scientists. The former argued that caste and class distinctions had radically diminished in Kerala over the course of the 20th century; the latter showed that, when it came to implementing the provisions of the 73rd and 74th Amendments to the Constitution, Kerala was ahead of other states. More power had been devolved to municipalities and panchayats than elsewhere in India.

Success, as John F. Kennedy famously remarked, has many fathers (while failure is an orphan). When these achievements of the state of Kerala became widely known, many groups rushed to claim their share of the credit. The communists, who had been in power for long stretches, said it was their economic radicalism that did it. Followers of Sri Narayana Guru (1855-1928) said it was the egalitarianism promoted by that great social reformer which led to much of what followed. Those still loyal to the royal houses of Travancore and Cochin observed that when it came to education, and especially girls' education, their Rulers were more progressive than Maharajas and Nawabs elsewhere. The Christian community of Kerala also chipped in, noting that some of the best schools, colleges, and hospitals were run by the Church. It was left to that fine Australian historian of Kerala and India, Robin Jeffrey, to critically analyse all these claims, and demonstrate in what order and what magnitude they contributed. His book Politics, Women and Wellbeing remains the definitive work on the subject.

Such were the elements of the 'Kerala Model'. What did the 'Gujarat Model' that Narendra Modi began speaking of, c. 2007, comprise? Mr Modi did not himself ever define it very precisely. But there is little doubt that the coinage itself was inspired and provoked by what had preceded it. The Gujarat Model would, Mr Modi was suggesting, be different from, and better than, the Kerala Model. Among the noticeable weaknesses of the latter was that it did not really encourage private enterprise. Marxist ideology and trade union politics both inhibited this. On the other hand, the Vibrant Gujarat Summits organized once every two years when Mr Modi was Chief Minister were intended precisely to attract private investment.

This openness to private capital was, for Mr Modi's supporters, undoubtedly the most attractive feature of what he was marketing as the 'Gujarat Model'. It was this that brought to him the support of big business, and of small business as well, when he launched his campaign for Prime Minister. Young professionals, disgusted by the cronyism and corruption of the UPA regime, flocked to his support, seeing him as a modernizing Messiah who would make India an economic powerhouse.

With the support of these groups, and many others, Narendra Modi was elected Prime Minister in May 2014.

There were other aspects of the Gujarat Model that Narendra Modi did not speak about, but which those who knew the state rather better than the Titans of Indian industry were perfectly aware of. These included the relegation of minorities (and particularly Muslims) to second-class status; the centralization of power in the Chief Minister and the creation of a cult of personality around him; attacks on the independence and autonomy of universities; curbs on the freedom of the press; and, not least, a vengeful attitude towards critics and political rivals.

These darker sides of the Gujarat Model were all played down in Mr Modi's Prime Ministerial campaign. But in the six years since he has been in power at the Centre, they have become starkly visible. The communalization of politics and of popular discourse, the capturing of public institutions, the intimidation of the press, the use of the police and investigating agencies to harass opponents, and, perhaps above all, the deification of the Great Leader by the party, the Cabinet, the Government, and the Godi Media - these have characterized the Prime Ministerial tenure of Narendra Modi. Meanwhile, the most widely advertised positive feature of the Gujarat Model before 2014 has proved to be a dud. Far from being a free-market reformer, Narendra Modi has demonstrated that he is an absolute statist in economic matters. As an investment banker who once enthusiastically supported him recently told me in disgust: "Narendra Modi is our most left-wing Prime Minister ever - he is even more left-wing than Jawaharlal Nehru".

Which brings me back to the Kerala Model, which the Gujarat Model sought to replace or supplant. Talked about a great deal in the 1980s and 1990s, in recent years, the term was not much heard in policy discourse any more. It had fallen into disuse, presumably consigned to the dustbin of history. The onset of COVID-19 has now thankfully rescued it, and indeed brought it back to centre-stage. For in how it has confronted, tackled, and tamed the COVID crisis, Kerala has once again showed itself to be a model for India - and perhaps the world.

There has been some excellent reporting on how Kerala flattened the curve. It seems clear that there is a deeper historical legacy behind the success of this state. Because the people of Kerala are better educated, they have followed the practices in their daily life least likely to allow community transmission. Because they have such excellent health care, if people do test positive, they can be treated promptly and adequately. Because caste and gender distinctions are less extreme than elsewhere in India, access to health care and medical information is less skewed. Because decentralization of power is embedded in systems of governance, panchayat heads do not have to wait for a signal from a Big Boss before deciding to act. There are two other features of Kerala's political culture that have helped them in the present context; its top leaders are generally more grounded and less imperious than elsewhere, and bipartisanship comes more easily to the state's politicians.

The state of Kerala is by no means perfect. While there have been no serious communal riots for many decades, in everyday life there is still some amount of reserve in relations between Hindus, Christians and Muslims. Casteism and patriarchy have been weakened, but by no means eliminated. The intelligentsia still remain unreasonably suspicious of private enterprise, which will hurt the state greatly in the post-COVID era, after remittances from the Gulf have dried up.

For all their flaws, the state and people of Kerala have many things to teach us, who live in the rest of India. We forgot about their virtues in the past decade, but now these virtues are once more being discussed, to both inspire and chastise us. The success of the state in the past and in the present have rested on science, transparency, decentralization, and social equality. These are, as it were, the four pillars of the Kerala Model. On the other hand, the four pillars of the Gujarat Model are superstition, secrecy, centralization, and communal bigotry. Give us the first over the second, any day.

On Economists, Politics and Experts

The economists have had another terrible year. It's time for a complete re-think

Jeremy Warner in The Telegraph


This may or may not be a good time for democracy, but one thing is certain about the past year of political upsets; it’s heaped further humiliations on the economics profession.

A substantial majority of economists thought the mere act of voting for Brexit would pole-axe the economy. Not only did voters ignore these warnings, but so far the “experts” have proved almost wholly wrong.
Internationally, the story is much the same. The profound shock to global confidence anticipated by the International Monetary Fund, the OECD , Uncle Tom Cobley and all, failed to materialise; Brexit had no discernible impact on the world economy. Having cried wolf over the short term consequences, the profession should not be surprised if rather more credible warnings of pain delayed are widely disbelieved.

Similarly with Donald Trump, where the widely expected economic and market mayhem his election would supposedly unleash has so far been conspicuously absent. This collective misreading has been widely attributed to the perils of “groupthink” – where opinion hugs the consensus for fear of derision - or more conspiratorially, to vested interest and deliberately misleading intent.

But there is in fact a more prosaic explanation; that as a discipline, the dismal science has quite simply lost the plot. All over the shop, economics seems incapable of answering the great questions of our time. Are we heading for deflation or inflation? Are we locked in secular stagnation or have we finally put the financial crisis behind us?

The conceit of modern economics is that it sees itself as an evidence-based science, yet if it could ever be such a thing, it is today no nearer its goal than when Adam Smith penned the Wealth of Nations, and in some respects, a good deal less so.

In a devastating recent analysis, the American economist Paul Romer asserted that macro-economics has been going backwards for more than three decades, with economic modelling succumbing to what he has called “mathiness”, an obsession with mathematic laws and equations which bear very little relation to the real world, ignore the lessons of other disciplines and are frequently out of touch with the inherently unpredictable nature of human behaviour.

When he wrote his treatise, Adam Smith was not an economist at all, but a professor of moral philosophy, yet many economists have come to believe that they should be as divorced from moral judgement as scientists – that economics should be a technical discipline free of ethical concerns. In the battle between moralism and mechanism, mechanism won. Unlike science, however, it doesn’t appear to have delivered anything remotely useful.

Few of the profession’s more recent failings should have come as any great surprise, for they merely follow the monumental breakdown in economic analysis exposed by the financial crisis. The Queen’s faux naïve question of economists at the time – “how come nobody saw this coming” – has yet to be answered.

As Andy Haldane, chief economist at the Bank of England, pointed out in a recent lecture, economic models provided an exceptionally poor guide to economic dynamics at the time of the financial crisis. Even after the crisis erupted, the profession seemed oblivious to its likely consequences. Virtually all the economic forecasts produced in the final quarter of 2007 – that’s after the collapse of Northern Rock - were not just mildly wrong about the coming year, but spectacularly so. Few saw any possibility even of a downturn, let alone the worst recession since the 1930s.

Mainstream economic modelling failed spectacularly during the financial crisis and has largely failed since

This failing has been explained by the Nobel prize winning economist Robert Lucas thus: “The simulations were not presented as assurances that no crisis would occur, but as a forecast of what could be expected to occur conditional on a crisis not occurring”. Thanks for nothing.

A somewhat similar excuse is proffered by HM Treasury for its ill judged analysis of the short term consequences of a vote for Brexit. This was not a prediction, but a “scenario”, it is claimed, based on two assumptions that turned out to be wrong – that Article 50 would be immediately triggered, and that there would be no countervailing monetary action by the Bank of England. Yet in truth, it was always obvious both that Article 50 would not be immediately triggered, and that the Bank of England would indeed take action to support the economy.

A stone when dropped will always fall to the ground. Human behaviour is by contrast far less certain, the result of a complex series of interactions which will always be inherently unpredictable, or what Mervyn King, former Governor of the Bank of England, has called “radical uncertainty”. The trouble with much modern economic modelling is that it assumes the laws of physics can indeed be applied to economics, or that behaviour will always respond to given inputs in a particular way. Time and again this has been proved incorrect.

The risks of this serial inability to diagnose what’s happening in the economy lie not just in the social costs of extreme events, or in wrong-headed policy response to them. It has also made mainstream macro-economics the object of political derision, which is in turn undermining public trust in key aspects of institutional and policy orthodoxy, including central bank independence and inflation targeting, which by and large have served us well.

Already we see some of this backlash in Trumponomics, where established norms, evidence and constraints are rejected in favour of policy based on instinct and narrowly perceived American self interest, including protectionism. These cranky alternatives threaten even worse outcomes than the faulty economics of the past.

Mr Haldane sees some reason for hope in reformed modelling, and in particular in so-called “Agency Based Models”, which take account not just of the observable environment, but also the behaviour of other agents which interact with it. Big Data promises to give these models even better predictive qualities.

Long applied to air traffic control, disease prevention, pharmaceutical drug trials and many other practical fields, use of ABMs in macro-economics is still very recent and far from commonplace. We can but hope they represent the great leap forward proponents claim.

One notable sceptic is the economist Paul Krugman, who claims that the old models didn’t fail, or rather that his own relatively simplistic Keynesian modelling predicted almost exactly the failure in post-crisis macro-economic policy. Ah, the path not taken. The beauty of this line of argument is that we’ll never know whether a different approach would have worked better.

Whatever the answer, economists need to be far more circumspect about prediction, as well as the uses their work are put to by the political class, where there is a growing tendency to cite the “experts” who seem to support the party line as true visionaries and dismiss the ones who don’t as useless propagandists. Pick your poison.

But let’s not entirely despair; undeterred by the low regard in which the discipline is held, there are apparently more students applying to do economics at university than ever. Economics may have lost its mojo, but plainly not yet its fascination.

The Shashank Redemption - Why not make administrators our role models?

ROB STEEN in Cricinfo

By putting a stop to the brief reign of the Big Three, Shashank Manohar has managed to do something that defied criticism © Getty Images


I simply couldn't believe all the filth which came out of their mouths. All day long. And to anyone. It was hilarious but unrepeatable, and because I wanted them to treat me as one of the lads, I accepted it.

You really know how to control a match buddy. It's a f***ing joke.

Two snapshots of sport in 2016, both from Australia, the nation that, some might say, put the "tit" in competitive.

That first reverberant sound bite emerged last week from England wicketkeeper Sarah Taylor, semi-fondly reminiscing about her recent experiences as the first woman to play the highest grade of male club cricket for Northern Districts in Adelaide. Somewhat unsurprisingly, she discovered that her ears and sensibilities were not going to be spared. As Bryan Ferry so eloquently put it, "Boys will be boys will be boys-yoy-yoys…"

The second, decidedly unsound bite came during last month's Australian Open, when that gifted but very naughty overhead smasher Nick Kyrgios hit fresh heights in his impressive assault on John McEnroe's all-time record for sporting officials harangued, abused and ridiculed. Indeed, at the end of the match in question, Kyrgios approached James Keothavong, the latest object of his loathing, and told the British umpire he was "a terrible referee", thus achieving the notable double of being at once searingly honest and hopelessly wrong.

What distinguishes the verbals encountered by Taylor from those delivered by Kyrgios, of course, is that the former occurred during a match that was not covered by the all-seeing, almost-all-hearing broadcasters. What further unites them is that the rules of the respective games, at amateur and professional level alike, empower the enforcers to penalise the offensive offenders. It is in the now-histrionic court of public approval that things get messy.

Naturally, there are those - almost invariably the sort of folk who claim to have first-hand memories of the '60s but were already too old to join in the fun - who will assure you that bad behaviour during a sporting contest is a strictly late-20th-century curse, triggered by the advent of unseemly rewards and the TV-fuelled obsession with personalities and controversy. This is, of course, absolute rot.

For no justifiable reason, playing sport for a living - unlike acting or singing or dancing or painting - means not only having to behave yourself, but being seen to behave yourself.

Ask Colin McDonald. Roused by Mike Atherton's recent contention that Fred Trueman and Brian Statham were England's No. 1 all-time co-manipulators of the new cherry, the dogged former Australia opener recently reflected on the might of Frank "Typhoon" Tyson: "I will never forget the remarks made by my opening partner Jim Burke during the 1959 Adelaide Test after a Tyson bouncer: 'If you bowl another one of those I'll knock your block off with this bat.' 'Will yer?' replied Frank. Not wishing to enjoy being the recipient of a similar delivery, my pleasant rejoinder to Tyson on his way back to his mark was 'Well bowled.'"

In emailing those wincing reminiscences to the Times, McDonald perhaps unwittingly highlighted the preposterousness of what might best be termed the sporting contract - that timeless unwritten constitution that obliges professional sportsfolk to seek victory at any cost but behave like a pre-pubescent Mormon; the same unwritten constitution that simultaneously obliges our competitive artists to remember, above all, that it's only a blimmin' game.

For those who regard ungentlemanly conduct as perpetually indefensible, last week's Under-19 World Cup game between West Indies and Zimbabwe in Chittagong proffered much to get high and mighty about. With one over remaining and the Zimbabweans requiring a further three runs, Richard Ngarava was "mankaded" by Keemo Paul, sending waves of disgust rippling around the planet.

Indeed, it says all too much about cricket's self-deluding self-image that a photograph of the incident made its way onto the English sports pages even though not one of Blighty's nine national daily papers sent a correspondent to the tournament - thus missing the lethally precocious magnificence of Alzarri Shaheim Joseph, a skyscraping Antiguan beanpole who seems destined to put Kemar Roach and Jerome Taylor to shame by becoming the millennium's first great lean, mean Caribbean pace machine.

In principle, this column agrees wholeheartedly with Tony Cozier: the notion of being honour-bound to deliver a pre-emptive warning is more than a little stupefying. For one thing, it's not as if we expect batsmen to stick their hand up and inform the bowler they're about to suddenly take guard the other way round. For another, baseball, cricket's uppity younger brother, has always been more clear-cut: if a runner is caught straying off base while sneakily seeking a head start, he's out and that's it. No ethical posturing or accusations of moral bankruptcy here. In fact, such dismissals are so common they have their own incriminating name: "picked off".



If Ched Evans wins his appeal and is re-signed by Sheffield United, will he be greeted with apologies? © Getty Images


Should we be perturbed that teenagers such as Paul appear to be every bit as prepared as their elders and alleged betters to seek any legitimate advantage available rather than concern themselves with something so nebulous as "the spirit" of the game? The opposite conclusion should be drawn: their priority is to demonstrate that they are capable of making the leap from outstanding amateurs to - at the very least - competent professionals.

For no justifiable reason, playing sport for a living - unlike acting or singing or dancing or painting - means not only having to behave yourself, but being seen to behave yourself. On and off the park. Why rugby flankers or NFL tight ends - whose job is to disrupt the opposition by virtually any means necessary - should be expected to be angels beyond the touchline is utterly beyond this column's ken. Since successful athletes tend to peak in their late 20s, all this column can say is that when it was that age, it was about as mature as day-old cheddar. Then there are the stresses and strains of doing one's job in public, unaided by an editor or body double, never mind in the incessant glare of the octopus otherwise known as the media. Shouldn't compassion be more prevalent than self-righteous, hypocritical indignation?

This is not to say there are not intensely problematic cases. Nor decry the many Sheffield United FC fans - among them the Olympic heptathlon champion Jessica Ennis-Hill, whose name was removed from a stand at Bramall Lane after she, along with many others, threatened to end their loyalty should the club re-sign the convicted rapist Ched Evans. Nor fault Atlanta Falcons for releasing Michael Vick in 2009 after the quarterback had spent 21 months in jail for running a dogfighting ring. Vick, though, rediscovered his mojo by kind permission of the Philadelphia Eagles. As for Evans, who has always maintained his innocence, his case has been referred to the Court of Appeal. What happens if the verdict is reversed? Would United re-sign him? Would (anti) social media resound with apologies?

"I'm not paid to be a role model. I'm paid to wreak havoc on the basketball court." Thus, in a largely forgotten 1993 commercial, stated the NBA star Charles Barkley, hitting the nail squarely on the head. "Funny how big shots accept all the trappings of role model-dom - especially the residual commercial cash - before they renounce their broader responsibilities to society," retorted Phil Mushnick in the New York Post. Meanwhile, in Sports Illustrated, Barkley's fellow NBA alumnus Karl Malone jabbed hard: "Charles... I don't think it's your decision to make. We don't choose to be role models, we are chosen. Our only choice is whether to be a good role model or a bad one."

Begging to differ was the Boston College sociologist Michael Malec, former editor of theJournal of Sport and Social Issues. "In essence Barkley is correct. If you want to emulate what he does on court, you've got a wonderful model there. That doesn't necessarily mean he ought to be a model as a father or husband."

Time, then, for a radical rethink: if we really must have role models, should we not look to the administrators, the purported adults? Plainly, suggesting even a tiny proportion fit the bill is tantamount to proposing that the next best option is Robert Mugabe (the current No. 1 global dictator, according to Forbes magazine, just ahead of Bashar al-Assad). Fishing a good guy out of the alphabet soup containing such toxic ingredients as the ICC, IOC, IAAF and FIFA, is akin to locating a needle in the Pacific Ocean.

Tim Wigmore was spot on when he pointed out that, before India - with a little help from their equally greedy, yellow-bellied pals in Australia and England - started muscle-flexing in earnest, the ICC was scarcely a model of enlightened governance. On the other hand, quoting the questionable wit and dubious wisdom of Rahm Emanuel, Barack Obama's former chief of staff ("Never let a serious crisis go to waste") was perhaps not the wisest choice.

Emanuel, after all, "seems committed", attested that zealous American scourge of bad sports Dave Zirin, "to win the current spirited competition as the most loathsome person in American political life". As mayor of Chicago, Emanuel demonstrated how the profits generated by spectator sport can distort social values. Having overseen the closure of 54 schools and six mental-health clinics under the justification of a "budgetary crisis", he handed over $100 million-plus to DePaul University for a new basketball arena.

What, then, of Shashank Manohar? In terminating the mercifully brief reign of the "Big Three" with suitable prejudice, he should be feted as the first major sporting administrator in recent memory to do something that defied criticism. Nonetheless, there are no fewer than three Ranji Trophy sides in his own state. As reader Jose P observed in a comment: "The diversity, and complexity of the well-entrenched multiple power centres within the BCCI structure, is a thousand gordian knots knotted into a more complex humongous knot."

Still, let's be generous and optimistic out there: anyone for the Shashank redemption?

Psychiatrists under fire in mental health battle

British Psychological Society to launch attack on rival profession, casting doubt on biomedical model of mental illness

• Jamie Doward
• The Observer, Sunday 12 May 2013

British psychologists are to say that current psychiatric diagnoses such as bipolar disorder are useless. Photograph: Justin Paget/Fuse/Getty

 

There is no scientific evidence that psychiatric diagnoses such as schizophrenia and bipolar disorder are valid or useful, according to the leading body representing Britain's clinical psychologists.
In a groundbreaking move that has already prompted a fierce backlash from psychiatrists, the British Psychological Society's division of clinical psychology (DCP) will on Monday issue a statement declaring that, given the lack of evidence, it is time for a "paradigm shift" in how the issues of mental health are understood. The statement effectively casts doubt on psychiatry's predominantly biomedical model of mental distress – the idea that people are suffering from illnesses that are treatable by doctors using drugs. The DCP said its decision to speak out "reflects fundamental concerns about the development, personal impact and core assumptions of the (diagnosis) systems", used by psychiatry.

Dr Lucy Johnstone, a consultant clinical psychologist who helped draw up the DCP's statement, said it was unhelpful to see mental health issues as illnesses with biological causes.
"On the contrary, there is now overwhelming evidence that people break down as a result of a complex mix of social and psychological circumstances – bereavement and loss, poverty and discrimination, trauma and abuse," Johnstone said. The provocative statement by the DCP has been timed to come out shortly before the release of DSM-5, the fifth edition of the American Psychiatry Association's Diagnostic and Statistical Manual of Mental Disorders.

The manual has been attacked for expanding the range of mental health issues that are classified as disorders. For example, the fifth edition of the book, the first for two decades, will classify manifestations of grief, temper tantrums and worrying about physical ill-health as the mental illnesses of major depressive disorder, disruptive mood dysregulation disorder and somatic symptom disorder, respectively.

Some of the manual's omissions are just as controversial as the manual's inclusions. The term "Asperger's disorder" will not appear in the new manual, and instead its symptoms will come under the newly added "autism spectrum disorder".

The DSM is used in a number of countries to varying degrees. Britain uses an alternative manual, the International Classification of Diseases (ICD) published by the World Health Organisation, but the DSM is still hugely influential – and controversial.

The writer Oliver James, who trained as a clinical psychologist, welcomed the DCP's decision to speak out against psychiatric diagnosis and stressed the need to move away from a biomedical model of mental distress to one that examined societal and personal factors.

Writing in today's Observer, James declares: "We need fundamental changes in how our society is organised to give parents the best chance of meeting the needs of children and to prevent the amount of adult adversity."

But Professor Sir Simon Wessely, a member of the Royal College of Psychiatrists and chair of psychological medicine at King's College London, said it was wrong to suggest psychiatry was focused only on the biological causes of mental distress. And in an accompanying Observer article he defends the need to create classification systems for mental disorder.

"A classification system is like a map," Wessely explains. "And just as any map is only provisional, ready to be changed as the landscape changes, so does classification."

An Alternative view on Modi's Gujarat

Illustration by Sorit            Opportunity Costs Of A Leader             The Gujarat model dispossessed and polarised millions, and scotched debate. Would India take it to heart? Suchitra Balasubrahmanyan

I moved to Delhi some three weeks ago after spending over three decades of my life in
Ahmedabad, prepared to be quizzed about the impending elections in Gujarat and whether the present government is likely to return to power for the third consecutive term; hear praise for peace returning to Gujarat after the violence of 2002, since no incidents of violence have taken place since then; and hear about Gujarat’s astonishing economic development and the prospect of the state’s leadership moving from Gandhinagar to New Delhi. I get all that.

But I also wonder if the people who ask me these questions realise that the Gujarat development model is inextricably linked with a certain set of ideologies, ambitions and aspirations which facilitate and sustain it?

In some ways, Gujarat is a microcosm of India. It has a great diversity of religions, castes and communities. The percentage of Muslim minorities in the state is just slightly lower than the national average. Dalits and adivasis together form about a fifth of Gujarati society, just as in the rest of India. (However, the Dalit-adivasi ratio is quite different). And all these communities, along with fisherfolk, pastoralists and the landless poor, have paid the price for helping realise the economic dreams of the state’s expanding, ambitious middle classes. Common property resources—coastal land, rivers and pastoral lands in rural areas—have been systematically taken over to make way for special economic zones and large industrial and infrastructure projects. Lakes and riverfronts have been gated and redeveloped as entertainment zones and real estate for the urban elite, dispossessing the poor, marginalised and the voiceless.

What is the worldview that underpins the shaping of such a socio-economic order? I am neither a political analyst nor a sociologist, just a teacher of design and I speak from direct experience. This is a development model, it’s plain to see, whose motive force is the ambition of the Gujarati middle class, made possible through large-scale dispossession and sustained only by denying dissent.

Anyone raising issues of equity, justice or sustainability associated with such a model of development is likely to be branded antediluvian at best and ‘outsider’, anti-Gujarat and pseudo-secularist at worst. Either way, dissenting views would find no space in the local media or in public discourse.
Since the 1980s, episodes of caste and communal violence have sharpened spatial segregation of communities, resulting in Muslim and Dalit ghettoes and upper-caste enclaves and declining social interaction. Muslims increasingly send their children to schools run by their community in their own localities. Within the municipal school system, they prefer the Urdu medium of instruction, while Gujarati medium schools are attended overwhelmingly by Dalit children. Schools are spaces for shared childhoods leading to adult bonds of friendship and understanding within accepted traditional social boundaries, but such spaces are no longer available. So it’s not Muslims and Dalits who are victims of social polarisation, but Gujarati society as a whole.

Anyone raising issues of equity or justice vis-a-vis the Gujarat model of development would be branded antediluvian at best, and anti-Gujarat ‘outsiders’ at worst.

After three decades of caste and communal violence, and almost fifteen years of the present political regime, we now have a generation of young Gujarati adults who know no other social order, no other way of being. The lack of access to diverse views through the media or public debate breeds intolerant parochialism and uncritical acceptance of the mirage of miraculous growth-rate figures. Perhaps, the middle class elsewhere is no different in its aspirations for a Gujarat style of development. But they might like to take a moment to consider the kind of social order that will inevitably accompany it and the political sanction it will receive. Would that be their idea of India? Significantly, cases related to the murder of an activist protesting against illegal mining in south-western Gujarat (he was murdered right outside the Gujarat High Court) and the blocking of community access to a river by a prominent industrial house are now before the Supreme Court. It is worth remembering that in the thousands of cases related to the 2002 riots that were closed in local courts, the process of bringing the perpetrators of communal carnage to justice had restarted only on the intervention of the SC. What will happen to democratic institutions of checks and balances if a Gujarati worldview were to be established nationally is anyone’s guess.

As a university teacher I can attest, as will other colleagues in design, architecture and management institutes in Ahmedabad, how difficult it is to even discuss ideas like secularism or social justice in the classroom, or to debate whether or not the state’s development model is socially and economically sustainable, or the human costs involved. Yet, I remain optimistic, happy with small signs that there is some intuitive goodness, even courage, in young people that shines through my experiences with students. This year, Id was celebrated at roughly the same time as the festival of Rakshabandhan. In a classroom assignment, students were asked to observe the social geography of the old parts of Ahmedabad. One student, a young woman, reported her observations of a side-lane flanked on one side by a Muslim mohalla and on the other by a Jain pol. Id decorations lined the mohalla-side of the road and rakhis were displayed for sale on the opposite side. She said she was really happy to see this, that the two communities could celebrate their festivals side by side. In another classroom project, architecture students were asked to visualise designs for the disputed Ramjanmabhoomi site, in accordance with the Allahabad High Court ruling. Each student in the class offered designs which, while complying with the ruling, brought the irreconcilable communities together, using the space creatively to resolve the differences.

While young people often echo the prejudice and parochialism that surrounds them, when given a chance to experience reality freely and to relate in a human way, they respond positively. Left to themselves, they can intuitively feel the rich web of their environment and respond humanely. But these impulses need nurturing, they need space to breathe and expand and be expressed. In Gujarat, and also in the rest of India.

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(Suchitra Balasubrahmanyan teaches at the School of Design, Ambedkar University, Delhi, and co-authored Ahmedabad: From Royal City to Megacity, Penguin 2011)

Risk models must be torn up, says Bank of England's Haldane

Financial risk models that underpin market behaviour, economic theory and bank regulation dangerously underestimate the threat to taxpayers and must be completely redrawn to prevent a repeat of the financial crisis, a leading policymaker has warned.
 

The Bank of England's Andrew Haldane has called for economists to re-think what they mean by "normal" 

 

By Philip Aldrick, Economics Editor

11:46AM BST 08 Jun 2012

57 Comments

 

Andrew Haldane, executive director for financial stability at the Bank of England, said the crisis provided compelling proof that “catastrophe risk” has been totally mis-priced. “That was a key fault-line during the crisis and, as recent experience attests, remains a key fault-line today,” he said in a paper at the University of Edinburgh Business School.

If taxpayers are to be protected in future, financial regulators must put “in place robust fail-safes to stop chaos emerging”, such as UK plans to ringfence banks’ retail operations or US proposals to ban casino-like proprietary trading.

Such “structural safeguards on worst-case outcomes” need to be accompanied by a massive increase in the “array of financial data available to regulators” provided by banks, he added. The extra information would allow regulators to build a “systemic risk map” not unlike a weather forecast that could “provide early warnings to enable defensive actions to be taken”.

“In a complex, uncertain environment, the only fail-safe way of protecting against systemic collapse is to act on the structure of the overall system, rather than the behaviour of each individual within it,” he said. “Until then, normal service is unlikely to resume.”

In a wide-ranging piece of research that sourced evidence not just from economics but from physics, biology and even behaviour on Twitter, Mr Haldane argued that the orthodox models used to measure risk overstate “normality” and underestimate the costs and probability of “catastrophe”.

To make the financial system safer, they need to be torn up, he said in the paper, co-authored with Bank economist Benjamin Nelson.

“The economics profession has for much of the 20th century been bewitched by normality. Real business cycle theory in economics and efficient markets theory in finance bear the tell-tale signs of this intellectual infatuation,” he said. “Over the past five years, the real world has behaved in ways which make a monkey of these theories.”

Changing the dangerous consensus “will require a fairly fundamental re-think of the foundations of modern-day economics, finance and econometrics”, Mr Haldane added.

Popular models that underpin banks’ risk management, such as Value-at-Risk (VaR), Black-Scholes and Vasicek, underprepare directors and regulators for a “fat tail”, or catastrophe event.

Citing studies of actuarial models used in insurance, Mr Haldane said “fat tails... would be expected to occur approximately once every 800 years for GDP and once every 64 years for equities”. “In reality, for GDP it appears to occur roughly once every century, for equities once every eight years.”

Regulatory risk measurements using the Vasicek model underestimate capital requirements by between 20pc and 85pc compared with a proper analysis of the past three centuries, he added. He cited JP Morgan’s recent $2bn trading loss as an example of the failure of VaR.

Changing the accepted wisdom on how to calculate risk is more important now than ever before, he added. “As the world becomes increasingly integrated – financially, economically, socially – interactions among the moving parts may make for potentially fatter tails. Catastrophe risk may be on the rise."

The mathematical equation that caused the banks to crash

 Ian Stewart in The Observer 21-02-12

It was the holy grail of investors. The Black-Scholes equation, brainchild of economists Fischer Black and Myron Scholes, provided a rational way to price a financial contract when it still had time to run. It was like buying or selling a bet on a horse, halfway through the race. It opened up a new world of ever more complex investments, blossoming into a gigantic global industry. But when the sub-prime mortgage market turned sour, the darling of the financial markets became the Black Hole equation, sucking money out of the universe in an unending stream.

Anyone who has followed the crisis will understand that the real economy of businesses and commodities is being upstaged by complicated financial instruments known as derivatives. These are not money or goods. They are investments in investments, bets about bets. Derivatives created a booming global economy, but they also led to turbulent markets, the credit crunch, the near collapse of the banking system and the economic slump. And it was the Black-Scholes equation that opened up the world of derivatives.

The equation itself wasn't the real problem. It was useful, it was precise, and its limitations were clearly stated. It provided an industry-standard method to assess the likely value of a financial derivative. So derivatives could be traded before they matured. The formula was fine if you used it sensibly and abandoned it when market conditions weren't appropriate. The trouble was its potential for abuse. It allowed derivatives to become commodities that could be traded in their own right. The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended.

Black-Scholes underpinned massive economic growth. By 2007, the international financial system was trading derivatives valued at one quadrillion dollars per year. This is 10 times the total worth, adjusted for inflation, of all products made by the world's manufacturing industries over the last century. The downside was the invention of ever-more complex financial instruments whose value and risk were increasingly opaque. So companies hired mathematically talented analysts to develop similar formulas, telling them how much those new instruments were worth and how risky they were. Then, disastrously, they forgot to ask how reliable the answers would be if market conditions changed.

Black and Scholes invented their equation in 1973; Robert Merton supplied extra justification soon after. It applies to the simplest and oldest derivatives: options. There are two main kinds. A put option gives its buyer the right to sell a commodity at a specified time for an agreed price. A call option is similar, but it confers the right to buy instead of sell. The equation provides a systematic way to calculate the value of an option before it matures. Then the option can be sold at any time. The equation was so effective that it won Merton and Scholes the 1997 Nobel prize in economics. (Black had died by then, so he was ineligible.)

If everyone knows the correct value of a derivative and they all agree, how can anyone make money? The formula requires the user to estimate several numerical quantities. But the main way to make money on derivatives is to win your bet – to buy a derivative that can later be sold at a higher price, or matures with a higher value than predicted. The winners get their profit from the losers. In any given year, between 75% and 90% of all options traders lose money. The world's banks lost hundreds of billions when the sub-prime mortgage bubble burst. In the ensuing panic, taxpayers were forced to pick up the bill, but that was politics, not mathematical economics.

The Black-Scholes equation relates the recommended price of the option to four other quantities. Three can be measured directly: time, the price of the asset upon which the option is secured and the risk-free interest rate. This is the theoretical interest that could be earned by an investment with zero risk, such as government bonds. The fourth quantity is the volatility of the asset. This is a measure of how erratically its market value changes. The equation assumes that the asset's volatility remains the same for the lifetime of the option, which need not be correct. Volatility can be estimated by statistical analysis of price movements but it can't be measured in a precise, foolproof way, and estimates may not match reality.

The idea behind many financial models goes back to Louis Bachelier in 1900, who suggested that fluctuations of the stock market can be modelled by a random process known as Brownian motion. At each instant, the price of a stock either increases or decreases, and the model assumes fixed probabilities for these events. They may be equally likely, or one may be more probable than the other. It's like someone standing on a street and repeatedly tossing a coin to decide whether to move a small step forwards or backwards, so they zigzag back and forth erratically. Their position corresponds to the price of the stock, moving up or down at random. The most important statistical features of Brownian motion are its mean and its standard deviation. The mean is the short-term average price, which typically drifts in a specific direction, up or down depending on where the market thinks the stock is going. The standard deviation can be thought of as the average amount by which the price differs from the mean, calculated using a standard statistical formula. For stock prices this is called volatility, and it measures how erratically the price fluctuates. On a graph of price against time, volatility corresponds to how jagged the zigzag movements look.

Black-Scholes implements Bachelier's vision. It does not give the value of the option (the price at which it should be sold or bought) directly. It is what mathematicians call a partial differential equation, expressing the rate of change of the price in terms of the rates at which various other quantities are changing. Fortunately, the equation can be solved to provide a specific formula for the value of a put option, with a similar formula for call options.

The early success of Black-Scholes encouraged the financial sector to develop a host of related equations aimed at different financial instruments. Conventional banks could use these equations to justify loans and trades and assess the likely profits, always keeping an eye open for potential trouble. But less conventional businesses weren't so cautious. Soon, the banks followed them into increasingly speculative ventures.

Any mathematical model of reality relies on simplifications and assumptions. The Black-Scholes equation was based on arbitrage pricing theory, in which both drift and volatility are constant. This assumption is common in financial theory, but it is often false for real markets. The equation also assumes that there are no transaction costs, no limits on short-selling and that money can always be lent and borrowed at a known, fixed, risk-free interest rate. Again, reality is often very different.
When these assumptions are valid, risk is usually low, because large stock market fluctuations should be extremely rare. But on 19 October 1987, Black Monday, the world's stock markets lost more than 20% of their value within a few hours. An event this extreme is virtually impossible under the model's assumptions. In his bestseller The Black Swan, Nassim Nicholas Taleb, an expert in mathematical finance, calls extreme events of this kind black swans. In ancient times, all known swans were white and "black swan" was widely used in the same way we now refer to a flying pig. But in 1697, the Dutch explorer Willem de Vlamingh found masses of black swans on what became known as the Swan River in Australia. So the phrase now refers to an assumption that appears to be grounded in fact, but might at any moment turn out to be wildly mistaken.

Large fluctuations in the stock market are far more common than Brownian motion predicts. The reason is unrealistic assumptions – ignoring potential black swans. But usually the model performed very well, so as time passed and confidence grew, many bankers and traders forgot the model had limitations. They used the equation as a kind of talisman, a bit of mathematical magic to protect them against criticism if anything went wrong.

Banks, hedge funds, and other speculators were soon trading complicated derivatives such as credit default swaps – likened to insuring your neighbour's house against fire – in eye-watering quantities. They were priced and considered to be assets in their own right. That meant they could be used as security for other purchases. As everything got more complicated, the models used to assess value and risk deviated ever further from reality. Somewhere underneath it all was real property, and the markets assumed that property values would keep rising for ever, making these investments risk-free.
The Black-Scholes equation has its roots in mathematical physics, where quantities are infinitely divisible, time flows continuously and variables change smoothly. Such models may not be appropriate to the world of finance. Traditional mathematical economics doesn't always match reality, either, and when it fails, it fails badly. Physicists, mathematicians and economists are therefore looking for better models.

At the forefront of these efforts is complexity science, a new branch of mathematics that models the market as a collection of individuals interacting according to specified rules. These models reveal the damaging effects of the herd instinct: market traders copy other market traders. Virtually every financial crisis in the last century has been pushed over the edge by the herd instinct. It makes everything go belly-up at the same time. If engineers took that attitude, and one bridge in the world fell down, so would all the others.

By studying ecological systems, it can be shown that instability is common in economic models, mainly because of the poor design of the financial system. The facility to transfer billions at the click of a mouse may allow ever-quicker profits, but it also makes shocks propagate faster.

Was an equation to blame for the financial crash, then? Yes and no. Black-Scholes may have contributed to the crash, but only because it was abused. In any case, the equation was just one ingredient in a rich stew of financial irresponsibility, political ineptitude, perverse incentives and lax regulation.

Despite its supposed expertise, the financial sector performs no better than random guesswork. The stock market has spent 20 years going nowhere. The system is too complex to be run on error-strewn hunches and gut feelings, but current mathematical models don't represent reality adequately. The entire system is poorly understood and dangerously unstable. The world economy desperately needs a radical overhaul and that requires more mathematics, not less. It may be rocket science, but magic it's not.
Ian Stewart is emeritus professor of mathematics at the University of Warwick.

Learning From China: Why The Existing Economic Model Will Fail

By Lester Brown

16 September, 2011
Earth Policy Institute

For almost as long as I can remember we have been saying that the United States, with 5 percent of the world’s people, consumes a third or more of the earth’s resources. That was true. It is no longer true. Today China consumes more basic resources than the United States does.

Among the key commodities such as grain, meat, oil, coal, and steel, China consumes more of each than the United States except for oil, where the United States still has a wide (though narrowing) lead. China uses a quarter more grain than the United States. Its meat consumption is double that of the United States. It uses three times as much coal and four times as much steel.

These numbers reflect national consumption, but what would happen if consumption per person in China were to catch up to that of the United States? If we assume conservatively that China’s economy slows from the 11 percent annual growth of recent years to 8 percent, then in 2035 income per person in China will reach the current U.S. level.

If we also assume that the Chinese will spend their income more or less as Americans do today, then we can translate their income into consumption. If, for example, each person in China consumes paper at the current American rate, then in 2035 China’s 1.38 billion people will use four fifths as much paper as is produced worldwide today. There go the world’s forests.

If Chinese grain consumption per person in 2035 were to equal the current U.S. level, China would need 1.5 billion tons of grain, nearly 70 percent of the 2.2 billion tons the world’s farmers now harvest each year.

If we assume that in 2035 there are three cars for every four people in China, as there now are in the United States, China will have 1.1 billion cars. The entire world currently has just over one billion. To provide the needed roads, highways, and parking lots, China would have to pave an area equivalent to more than two thirds the land it currently has in rice.

By 2035 China would need 85 million barrels of oil a day. The world is currently producing 86 million barrels a day and may never produce much more than that. There go the world’s oil reserves.

What China is teaching us is that the western economic model—the fossil-fuel-based, automobile-centered, throwaway economy—will not work for the world. If it does not work for China, it will not work for India, which by 2035 is projected to have an even larger population than China. Nor will it work for the other 3 billion people in developing countries who are also dreaming the “American dream.” And in an increasingly integrated global economy, where we all depend on the same grain, oil, and steel, the western economic model will no longer work for the industrial countries either.

The overriding challenge for our generation is to build a new economy—one that is powered largely by renewable sources of energy, that has a much more diversified transport system, and that reuses and recycles everything. We have the technology to build this new economy, an economy that will allow us to sustain economic progress. But can we muster the political will to translate this potential into reality?

Lester Brown is an United States environmentalist, founder of the Worldwatch Institute, and founder and president of the Earth Policy Institute, a nonprofit research organization based in Washington, D.C. BBC Radio commentator Peter Day calls him "one of the great pioneer environmentalists."

Copyright © 2011 Earth Policy Institute