Read whichever classic economist you like and you’ll soon hit upon the theory of growth economics. In the 1870s, aspiring economists, seeking to emulate physicists like Newton, tried to create an economic theory with neat diagrams that showed the role played by market forces and mechanisms in pulling an economy into equilibrium; a set of ‘economic laws of motion’, if you will.
In 1955, the economist Simon Kuznets thought he had found such a law of motion, one that determined the path of income inequality in a growing economy. According to Kuznet’s curve, as a nation’s GDP grows, inequality first rises, then levels off, and ultimately starts to fall. Even Kuznet, however, said it was based mainly on speculation but nonetheless it was soon adopted and immortalised.
Fast forward to the economists of today and you’ll soon come across questions around the validity of such models. Thanks to more and better data, it has become clear that economic laws of motion simply don’t exist. Yet the old theories still pervade. Why is this? Partly because we hate to challenge the status quo. If you’ve ever tried implementing change in your workplace, you will no doubt have encountered some of these arguments:
- ‘That will never work here’
- ‘It’s fantastic, but the salesforce won’t like it’
- ‘Maybe in the next budget cycle.’
We use many methods to justify to ourselves why we stick to what we’ve always done. Similarly, there are many ways to make growth economics seem ‘right’, if we ignore some of the negative impacts, such as extreme inequality and environmental degradation. This is how it has become a justification for ‘trickle-down economics’ and for the enduring austerity of today in the pursuit of making everyone better off someday.
The same is true with investing and advice; in the nineties, many people had no problem with commission. Then, after RDR in 2012, the whole nature of financial advice dramatically changed. Until recently, the concept of achieving greater returns through algorithm investing hadn’t even been invented. Yet times change and systems have to evolve with them. There are no givens and even old models – ‘this is how investing has always been done’ and ‘established economic patterns’ – should be seen in a new light.
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