New Perspectives

In Economics and Finance

Economics Turns Math on Its Head

One would think that research is objective, but it’s become clear that personal biases permeate even the most rigorous studies. There’s no denying that 2+2=4.  Regardless of who you are or how many times you calculate it, you will always get the same number. The same is true of those globally ubiquitous metrics used to assess the economic performance. We’re not talking about projections of the future or statistical probabilities so commonly used among economists which give opportunity for interpretation and a margin of error. We’re talking the simplest of calculations using data from measurements which have already been observed. No matter where you are in the world or how many times you calculate it, a company’s return on assets will always come-out the same. Despite the consistency with which these equations are solved, the exact meaning of the answer varies depending on who you are. Though 2+2=4 will be the outcome every time, studies in behavioral economics have shown that the exact nature of what 4 means is a variables that depends on your psychological frame – all the experiences and knowledge and genetics and social influences that have shaped the way in which you see and respond to the world around you, even things deemed as universal as math.

Looking at even just one influence of our psychological frame – culture – we find a wealth of perceptions and responses to very basic calculations of economic equations. Corporate dividend payments are the kind of thing that one would think is determined entirely by the amount of profits and whether companies can generate greater returns by reinvesting those profits, but it’s been found that dividend payments are determined largely by the cultural dimensions of Mastery and Conservatism.* One would think that whether or not it is worth investing in something, anything from a piece of new equipment to some specific stock, would be determined by very common metrics of risk compared to the “risk free rate” (the returns generated by short-term government debt), but it has been discovered that these decisions are strongly and consistently the result of cultural uncertainty avoidance.* The amount of trade and investment nations have together, it would appear, that all other things being equal would be determined objectively by the price of the things being bought and sold, but even these factors are the result of behavioral sources.* The 2013 UN World Investment Report * shows that economic integration is occurring at a more rapid rate between nations of similar cultures, confirming a other studies proving that nations which are more different from each other culturally will have lower capital trades with each other regardless of the potential gains.***

Simply put, people from every nation on the planet could be looking at the exact same stock investment, using the exact same metrics of risk and reward, yet investors from a nation whose culture is very different than the nation where the stock is from will have a higher cost resulting from different interpretations of identical calculations being performed.** Thankfully, simply recognizing the fact that each of us understands what calculations mean slightly differently allow us to make corrections. There are many factors beyond just culture that shape our psychological frame, but by identifying those factors which influence us allows us to develop factor-based adjustments so that each of us can more accurately see a central truth constructed from perceptions allowing us to make more accurate decisions but also helping to eliminate personal bias in what should otherwise be objective research.

Michael Taillard is a professional economic consultant and researcher, specializing in strategic management and behavioral science. His books include Economics and Modern Warfare (2012, second edition forthcoming 2018), Psychology and Modern Warfare (2013), Corporate Finance for Dummies (2012), 101 Things Everyone Needs to Know about the Global Economy (2013), and Aspirational Revolution (2017).