Since the Great Recession that began in late 2007, there is a growing feeling that economics is not serving us well. There is truth to this hunch, but the reasons are more complex than most people realize.
Academic disciplines are built on assumptions; the most tried and tested of these are often enshrined as axioms. When economic policies go wrong, the standard practice is to rush to examine those axioms. Are some of them incorrect? Economists collate statistics, create new data using randomized trials, collect impressionistic information, and often come out with the conclusion that some of the established axioms are not quite right. Correct them, and one will get better predictions and better policy. Such an approach can work under normal circumstances, but when economic outcomes go deeply wrong, the problem may be more foundational: not in the axioms of the discipline but in the unstated assumptions—the "assumptions in the woodwork," which all disciplines have and which we are usually unaware of.
The most striking example comes from geometry. Euclid's Elements contained an assumption that was never stated explicitly, and it is not even clear that Euclid was aware of it: the presumption that his experiments were conducted on a flat, two-dimensional surface. But if Euclid's work was premised on a curved surface, such as that of the Earth, Euclidean geometry would be flawed. This was realized in the early 18th century by the Swiss mathematical genius Leonhard Euler, and through his work and that of several other mathematicians, such as Germany's Carl Friedrich Gauss, non-Euclidean geometry was born.
Euclid's error, if we can call it that, did not matter much when human beings did not travel and trade over great distances—at least not over short durations of time. This is because over short spaces, a flat surface is a good approximation of a gently curving one. When, from the 15th century onward, it became common to travel long distances for trade and conquests, initially by ship and then by plane, it became critical not to base calculations on Euclidean geometry. The curvature of the Earth mattered. We need to step beyond economics to understand the 21st century's troubled economies.
To understand the analogy for economics, consider trade. Much of human well-being depends on our ability to conduct trade and exchange goods. If each household had to produce all that it consumed, our lives would be solitary, poor, and short. What leads to efficient trade and exchange? Economists usually point to a few assumptions, such as self-interest (in particular, the urge to accumulate and consume more), the axiom of diminishing marginal utility (the fact that consuming more of the same good causes utility from each additional unit to decline), and so on. But these assumptions are in fact inadequate. Laboratory tests show that rats satisfy these axioms, too, but there is no evidence of trade among rats. For society to conduct trade, these economic assumptions need to be supplemented with other social and normative preconditions: We need language, the ability to communicate, and some minimal respect for others' rights. These are the assumptions in the woodwork that economists are often unmindful of but play a vital role.
Put simply, markets, trade, development, and economic growth are made possible by a bedrock of social norms beneath the economy. When these norms are not there or they mutate, the economy can teeter or even collapse. One can see the importance of this in today's world. There is a lot of soul-searching about the malfunctioning of standard policy. Central banks cutting interest rates and increasing liquidity are failing to revive growth and create jobs. The Phillips curve—the theory stating that inflation and unemployment have a stable and inverse relationship—is in tatters. Economies that were doing remarkably well are suddenly stalling and stumbling. It will need research and analysis to locate all the fault lines causing these problems, but it is arguable that with globalization, societies with very different norms are coming to inhabit a common playing field and this is causing strains not seen before, as would happen if two sets of islanders, one that followed the norm of driving on the left and one that drove on the right, came to live on the same island. In brief, we need to step beyond economics to understand the 21st century's troubled economies.
India presents a striking example of the limitations of pure economics. From 2003 to 2011, the world's largest democracy was growing at a phenomenal rate, exceeding 9 percent each year between 2005 and 2008. Even after 2011, it kept up a reasonable rate of growth. However, since 2018, the economy seems to be spinning into a crisis, with growth declining to 4.5 percent, consumption in India's vast rural sector declining at rates not seen since the late 1960s, and the overall unemployment rate at a 45-year high. The 2018 Accidental Deaths and Suicides in India Report, recently released by the National Crime Records Bureau, highlights a stark mood of despair: Since 2017, there has been a noticeable rise in the relative share of suicides by daily wage earners. They are among the poorest people in the economic ladder, thereby suggesting a rise in poverty.
What is causing this economic turnaround in a country that until a few years ago was perceived as exemplary? Mistakes in fiscal and monetary policies have played a role, of course. But the sharpness of the decline suggests that something more is going on, and part of the cause lies in ruptures in the normative and institutional foundations of the nation caused by divisive politics.The rise in divisive politics, whipping up of religious tensions, and marginalization of minorities … are undoubtedly taking a toll on people's sense of belonging and trust in the nation.
Trust and a sense of belonging are not economic variables, but they form an important part of the underlying normative foundation of an economy. These values are eroding in India. An important hint of this comes from the decline in India's investment rate—investment being dependent on trust and confidence—from nearly 39 percent of national income seven or eight years ago to 30 percent today. This may well be contributing to the slowdown. Market economies rely on trust in several ways. For most transactions, there is a gap between service and payment. The auto shop repairs your car today, and you pay tomorrow. You pay the painter today, and she paints your home over the following week. Without trust, all these transactions would slow down and malfunction. Francis Fukuyama noted the correlation between a society's level of trust and economic prosperity, and, in a 2013 paper, Yann Algan and Pierre Cahuc use statistical analysis to show that trust can be critical for economic growth. By their calculation, an Africa with Sweden's trust levels would achieve six times the per capita income it currently has.
A recent Harvard Business Review paper shows that if a company's workers have a sense of belonging, they improve their job performance by 56 percent, with a 50 percent drop in churn and a 75 percent reduction in sick days. For a 10,000-person company, this would result in annual savings of more than $52 million. Extrapolate this to a nation, and you get a sense of why nations where large segments feel excluded do poorly.
The rise in divisive politics, whipping up of religious tensions, and marginalization of minorities that we have seen over the last four or five years in India are undoubtedly taking a toll on people's sense of belonging and trust in the nation. This is an important reason India's economy is doing so poorly.
The role of trust and sense of ownership get endorsement from a very unusual source: The British music conductor Charles Hazlewood noted in an interview that while discipline and obedience play an important role in a successful performance, the critical element between the conductor and individual musicians is trust. Giving them space to use their own judgment and creativity is what leads to truly great music.
Something similar is likely true for the economy. With globalization and dramatic changes in technology, our world is transforming beyond recognition. It is not enough to simply collect data and examine the axioms of economics. Instead, economists must unearth some of the hidden assumptions of our discipline—the norms that we, knowingly or unwittingly, assume to be there, which may not be there or may have shifted. It is time to bring anthropology into economics and to rewrite our models. In short, this may well be economics' Euclidean moment.
The author, Kaushik Basu, is a professor at Cornell University.