Good Foundations – Econlib

In the Christian Bible, there is a parable of two builders.  One built his house on stone and the other on sand:

“Everyone then who hears these words of mine and acts on them will be like the wise man who built his house on rock.  The rain fell, the floods came, and the winds blew and beat on that house, but it did not fall, because it had been founded on rock.  And everyone who hears these words of mine and does not act on them will be like a foolish man who built his house on sand.  The rain fell, and the floods came, and the winds blew and beat against that house, and it fell – and great was its fall!” -(Matthew 7: 24-27, NRSV)

This parable finishes the famous Sermon on the Mount, in which Jesus Christ lays out what one must do to live a good life, be a good person, and worship God.  A life built on solid principles can withstand many things: whether winds buffet, rain pours, or waters rise, the person soldiers on.  In contrast, a life built on unsolid principles collapses as soon as the bad times hit.

The same is true of economic reasoning.  Econ 101 (or Econ 211 as it is called at my university), Principles of Microeconomics, is a foundational course.  One of the things I tell my students is that all their subsequent business courses build on these foundations.  If they can understand the foundations, then everything will flow from that.

When I teach upper-level courses (International Trade, Money & Banking), I always reference back to Principles to reinforce appreciation of the power of principles-level economic thinking.  I frame things in terms of incentives: “Why is it that bond yields and bond prices move in opposite directions?  Don’t just tell me mathematically…what’s the incentive here?”  “Why do bonds trade at a discount when the coupon rate is below the market rate?  Don’t just tell me mathematically…what’s the incentive here”? These are questions that appear on my exams.

Foundational knowledge is vital to understanding. Understanding the foundations makes economic relationships intelligible.  You may not know the precise answer (that’s where the math comes in), but often you can know when the answer you get is incorrect.

Mathematics is a useful tool, but if not coupled with foundational economics, the findings are unstable—like building a house upon sand. A mathematical model may look pretty and still fall apart once the situation changes.  We see this all the time, especially with pundits like Michael Pettis and Oren Cass who toss out economic foundations and build towering edifices upon sand, only to have them collapse under scrutiny (see, for example, my post “Accounting Identities and Economic Theories” and Brian Albrecht’s post “Curing International Trade Confusion“).

Even now, in a chaotic economic environment, I find that relying on the lessons learned in Econ 101 serves me well.  They help me filter out the noise so we can focus on the signal.

So, my advice for anyone who wants to understand, truly understand, economics: learn your fundamentals.  Build your education on a solid foundation.  It’ll help keep your eyes clear when others try to dazzle with fancy mathematics or logical conundrums.  If they cannot link it back to economic foundations (or worse, make some appeal like “econ 101 is too simple!”), you will be able to see that you are being shown nonsense on stilts.