Economics & Finance

& finally:

Some comments on "economics":

If you're wondering, in response to the title of this page, "What's the difference between economics & finance?", don't worry, you're not alone.  I didn't used to know and perhaps more worryingly, it's clear that a lot of public servants, politicians and business leaders don't know either.  The answer is that "finance" is about money (typically finance for investments) whereas "economics" is the theory of human "welfare"; that is, an attempt to conceptualise, analyse & model how everything interacts in society to make people well & happy (or not).  As such, it is concerned with and should model everything significant that's important to people, including their health, the environment, future generations, etc.  In practice this is done by converting non-financial things to a monetary value (so they can be compared with each other), although with varying degrees of sophistication, competence and honesty!  Typically economics is concerned with maximising the totality of all human wealth/welfare/happiness, without regard to the equality of wealth distribution (or lack of), although I think it should be concerned with the latter (which can be modelled using "utility" functions that recognise the vastly greater wellbeing that a dollar offers to a poor household compared to a rich one).

"Economic" benefit-cost analysis is the standard tool for evaluating the merit to society of potential government investments, including (in principle) all social & environmental impacts, with discounting of future costs and benefits used to properly weight short & long term impacts (contrary to common misinformed critique that it inappropriately "discounts the future").  My thoughts on the appropriate discount rate are here.  NB. The Grattan Institute make similar end conclusions, though with somewhat different reasoning, but I don't support their suggested categorisation of certain transport modes as 'low risk', because the natural monopoly nature of major roads & rail lines means there is no competitive market to facilitate diversification of project-specific risks (except for with buses, when you can redeploy the asset).

The poor understanding of economics' wide scope is probably not helped by "the economy" being used to refer to only those activities that are traded with money, which unfortunately leads some people to discount the importance of non-traded activities and others to retort that people should be concerned by more than just "economic" matters (which by the true definition of "economics" is an empty set!).  We need rational economics to guide good public policy; after all - as Paul Keating said - would you rather have irrational economics??!  But it needs to be a sophisticated kind, not the over-simplified, ideological kind that has given "rational" a bad name.  When used judiciously, economics can be useful to better understand the inter-related nature of society - how changing one thing affects another & another - which can inform better decision-making and help avoid "unintended consequences".  However, the real world is not the simple free-market model some would like or pretend it to be, and unfortunately it is all too common for overly-simplistic theories or even deliberately-misleading complex, "black box" economic models to be misused to 'justify' predetermined positions whilst avoiding true scrutiny (not least for transport project appraisals and greenhouse policy).  For this reason I tend to prefer simple & conceptual economic models, wherever possible.