(featured image credit: torstensimon)
The peculiarly human nature of economics
On Wednesday 10 January Philip Hammond, the UK’s chancellor of the exchequer, and his cabinet colleague David Davis, the secretary for Exiting the EU, flew to Germany. The aim of their trip was to present Britain’s view of what a ‘strong and close’ post-Brexit relationship with the EU, and in particular with Germany, should look like. Earlier the same day, an article written jointly by both gentlemen was published in one of the main German dailies, the Frankfurter Allgemeine Zeitung. In it they argued that it would make no sense for either Germany or Britain to put in place “unnecessary barriers” that would damage businesses and economic growth.
Sounds like a no-brainer – why would anyone erect unnecessary barriers? Why would there need to be impediments to trade, compared with the present seamless situation that the UK enjoys as a member state of the EU (and by implication of the Single Market and the Customs Union)? Why impose tariffs, or non-tariff barriers (such as paperwork and border checks) that would depress trade, and hence cause a material economic loss?
Living in an immaterial world
Does this look like an unnecessary barrier? (photo: distel2610)
Material losses are not unusual though – in fact they are incredibly common. Every time we buy something, our wallet ends up lighter, our bank account gets depleted, or we increase our credit card debt. But that financial loss can be compensated by a corresponding material gain. When we buy a washing machine we gain time through its efficiency, as it can clean our clothes much more quickly than we could, doing it all by hand. When we buy home insurance, the fact that we can claim on our insurance when our house goes up in smoke is a clear material benefit too: we don’t gain anything directly, but we prevent economic loss.
But not everything transaction has a purely material balance. When we purchase curtains for the bedroom, lest the neighbours see us in dramatic states of undress, there is not really any demonstrable tangible benefit. So why do we spend money on them? We make the expense to satisfy a spiritual need – not in any religious sense, but in a philosophical sense. We don’t want our neighbours to see us in the nude. It would make us feel embarrassed or ashamed – and the avoidance of this feeling is worth the cost of the curtains.
Much of our economic life is conditioned by such immaterial considerations. A lot of the stuff we buy has marginal or no direct material benefit. We could perfectly function with a small fraction of the clothes in our wardrobe, with cheap food, without a television and so on. They all provide us with utility that is immaterial.
Some of us prefer more expensive fairtrade goods, even though they do not provide any superior material value. Some prefer to buy local, or national – again, with at best highly debatable concrete benefit. Even choices that don’t directly involve money can be made based on immaterial considerations: maybe we frequent a newsagent that is a bit further away because the nearby one is a grumpy git.
It is not really different in Brexitland. The EU-27 want to preserve the integrity of their internal rules, and for example not compromise on the four freedoms of movement: capital, goods, services and people. It is clear that, if the eventual deal between the UK and the EU-27 reduces these freedoms, there will be an economic cost. But they are prepared to bear that cost, in order to preserve what is essentially an immaterial value.
Is that mystifying? Not really, or at least no more mystifying than any other trade of material benefit for some immaterial utility. And certainly no more mystifying than the UK’s decision to leave the EU (and its subsequent intention to leave the Single Market, the Customs Union and the jurisdiction of the European Court of Justice). The motivation was ostensibly “to take back control”. Sure, in theory there is a material upside of around £8.5B net every year, but if trade is hindered by a restriction of the freedoms of movement, the likely consequential cost are likely to be considerably higher. This cost must therefore necessarily be offset by the immaterial benefits of sovereignty: no longer being subject to EU laws, and of being able to restrict immigration.
So both the EU-27 and the UK are incorporating immaterial elements in their decision-making. And unlike material assets, they cannot be objectively valued. The best estimate we have is based on an economic concept of questionable validity, that of revealed preference. By making the choices they make, both sides ‘reveal’ the value of the immaterial part of the equation.
Not irrational
We should not make the mistake of uttering the I-word here. All too often, poorly understood immaterial utility is misinterpreted as irrationality. Is it irrational for a child to prefer two 50p coins over a single £1 coin? Not really. The little kid quite likely derives very genuine pleasure from holding two pieces compared to just the one. Unless we know what the immaterial utility is of something people pursue (or, in case of negative utility, seek to avoid), we cannot and should not conclude they are being irrational.
But the problem with valuing immaterial benefits or costs doesn’t just affect our perception of others’ choices. When we need to make trade-offs between material and immaterial consequences of a choice, can we really work out precisely what the true price is of the immaterial element? Hardly.
Or actually, yes. Our physical requirements are to a large degree determined by our physiology. We need food, which needs to be of a certain energetic value, and of a certain composition to provide us with the essential nutrients we need. We need water to keep our anatomy working. We need protection from the elements, so we don’t die prematurely of hypothermia and so on. We share that type of need with every living organism. They are outside our control – we cannot decide to survive on fewer calories than we really need, or without water or vitamin C.
The stuff that happens behind closed curtains… (photo: Juergen_G)
But our immaterial needs? There we would appear to have a choice. Do we worry about whether the coffee and sugar in our pantry are fairtrade? We decide. Do we care whether the people living in our street were born in our own country or not? What colour their skin, or what their religion is? Up to us.
We can even decide whether or not we care that the neighbours can verify whether we have naughty bits (just like they have), and save the cost of curtains in our bedroom – although we may need to check we’re not falling foul of laws regarding exhibitionism.
The great economist John Maynard Keynes spoke of animal spirits to refer to the emotions that sometimes guide our economic decisions. But actually, it’s the immaterial aspects of our economy and economic behaviour that reflects our humanity, rather than what we share with the animals.
Koenfucius 