Why Read Theory? The Launch of Schools and Thought

In academia, economics and finance majors are taught the principals of their fields as truths in a textbook backed by math and statistics. Students of economic theory are taught the principals of economics through original theorists and primary sources. The end result tends to lead those students who just studied the principles of economics or finance to have an over-simplified view of markets. And those students who just studied theory often lack the pragmatic and directly useful models that students of economics and finance learn.

I was originally a student in the former group and I remember arguing with an acquaintance in the latter group. We were both freshmen. I had just finished my first microeconomics course and he had taken a globalization and philosophy course (or something like that). He started talking about how he was a socialist and loved Marx. I told him that  I disagreed and could prove my point with basic economic models. I explained how supply and demand work in a labor market and how a centrally planned market leads to deadweight loss. He disagreed and tilted the subject towards his anti-consumerism and his belief that people should do good for others. I pulled out some of my economics homework and tried to show him the deadweight loss triangle on my graphs. He disagreed with the entire premise of the idea that humans are self-interested. He told me how Marx was a utopian, and that the idea behind the theory wasn’t that the system was wrong, but that we should work so that in the future the assumptions about human nature underlying the field of economics would change. Our end discussion had us both saying “dude, look, seriously, think about it.”

While I still think he was wrong, I did later learn that there were many important theories and assumptions underlying economics that we weren’t taught in class. And even if some economics students are lucky enough to have a professor who teaches them, or even seeks out the knowledge on their own, finance students in a business program will rarely read theory. Often even PhDs and professors who lean heavily towards the quantitative side don’t study much theory. That’s not necessarily a bad thing. There are some econometrician PhDs who are incredibly smart and useful that don’t study theory. But it can have its drawbacks.

Every model, equation, number, asset allocation, new financial product and investment is built upon layers of theory that rest on assumptions about human nature. Physics, biology, math, statistics, chemistry, and an array of other sciences do not require us to consider human nature, but complicated quantitative arbitrage models rest on human nature. Many of the most intelligent and successful theorists, from Keynes to Buffet, try to explain that to truly understand markets people need to look deeper. Keynes argues that stock prices are a convention. We can use models to approximate what the prices encapsulate, but at its core the idea of a share of a company having a price is a human convention. Buffet believes some products can be undervalued, meaning that the buyers aren’t able to connect the share price with its ‘true’ value. Or, in other words, that Buffet is better able to perceive true value than other players in financial markets based on his personal philosophy.

If you want a job right now, learning a programming language or being strong with Excel will likely be more useful than picking up and reading economic theory. But if you want to work in the field of at a higher level, understanding the theory and philosophy that builds up your profession will be a powerful skill (I’m just guessing, I’m only 22 and haven’t had a chance to test this theory out yet. I’ll get back to you). This blog will cover a wide-range of topics in the fields of economics and finance. I hope you find it educational and are inspired to explore the world of theory on your own.


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