Behavioural Finance and Economic Paradigm - Literature review Example

Behavioural finance Table of Contents 3 Introduction 4 Inclusion criteria 4 Exclusion criteria 5 Literature Review 5 Different views of the researchers 6 Conclusion 11 Reference List 12 Abstract The literature emphasises on the need for a new economic paradigm. Economic paradigm is required for facilitating development of the global economy. This need is realised by every country around the world, but the government and higher authorities are reluctant to fulfil the same as it entails a huge investment. Hence, it is not plausible for the poor countries to incorporate and encourage the change. The environmental changes are frequent and unavoidable, but economic model change is rare and difficult to attain for any economy. Many scholars have proved that the present economic standard model had been unsuccessful in bringing about any improvement to the economy. Thus, there is a need for a new economic paradigm that can enhance the economic condition of all countries. The literature lays stress upon different views of the scholars and researchers related to the current topic. It is observed that few of these scholars are in favour of the idea, whereas others have directly opposed the same. Introduction Presently, there is a great need for change as individuals perceive that economic, social and environmental shifts are necessary. The global population is increasing at an alarming rate accompanied by an extraordinary improvement in life expectancy worldwide. Innovations made in the technological industry have enabled the people to learn and communicate essential information on a global level. The inequality between poor and rich countries has continued to grow with the passage of time. The demand for natural resources has increased and climate changes are more frequent than ever. The main issue related to the world economy is the most severe one. Apart from the abovementioned difficulties, the economic paradigm is also questioned as the world economy is heading towards a decline (Reza, 1999). The economic condition worsened as the blame game persisted so as to identify the one responsible for the economic downturn and recession. Primarily, the blame was put on the financial managers who had failed to identify and manage risk appropriately and even the regulators did not stop them from undertaking any fraudulent activity. The economic strategy devised for promoting growth was inadequate. Businesses and governments had stated the need for a new economic paradigm, which can facilitate sustenance of the environment. New Economics Movement had rapidly grown over the past few years. New Economics Foundation and The Other Economic Summit formed a part of the movement. It had clearly identified that the present economic model is the main base for macroeconomic policy. The movement also indicated the manner in which the global economy was separated from ethics, given that the emphasis was on money values and the aspect of humanity was entirely ignored. As a result, the economists felt the need for a new economic paradigm that will realise one-world economy. The current research highlights on whether or not a new economic paradigm is required for controlling the present economic condition globally (Etzioni, 1998). Inclusion criteria The book, written by Stiglitz and Greenwald (2003), “Towards a New Paradigm in Monetary Economics” is very helpful in the project as it described the overall requirement of the project. It details each and every particular that are required in the economy for its development. The authors have specified that new paradigm change is necessary for the betterment of the global economy. Though its benefits are questionable but the changes are highly recommendable. Shaffer and Wright (2010) in their article “A New Paradigm for Economic Development”, has defined the need for a new paradigm for the global economic development. The article has provided information regarding why the new shift is necessary and the disadvantage of the same Exclusion criteria There are many articles that are deemed irrelevant for the project as it does not relate to the global economic development. Among them on one of the article is “Integrating technology into teaching: a new paradigm shift?” does not have any relevance with the topic as it does not relate to the global economic development. Literature Review The literature foregrounds the requirement of a new economic paradigm by emphasizing on its definition and relevance in the present economy. The new economic paradigm will aim at forming a one-world economy comprising a multi-level system. The new paradigm needs to induce ethical and political values in an economy. It will take into account the principles pertaining to conservation of nature as the static principles such as, equity and social justice, are not sufficient, but crucial indeed. The new paradigm will consider the community and households as the basic building blocks. The new paradigm is applied to both international and national economies (Etzioni, 1998). Presently, the measures undertaken for facilitating economic growth are not appropriate in respect of human welfare. The leaders of every nation are seen to debate regarding the fact that economic growth should be maintained so as to repair the environmental and social damage entailed. Over several decades, the economic system established had failed to protect women, provide the native people with a comfortable livelihood, effectively eliminate poverty and control the degradation of environment (Stiglitz, 2010). Different views of the researchers Economists have concentrated on distinguishing between the qualitative and quantitative measures pertaining to growth. They identified that the measures considered ignore free exchanges that are voluntarily undertaken by the individuals in an economy. The principles of economic growth do not favour zero growth. If this particular point is taken into account, then the argument, “growth itself is not a meaningful measurement” (Stiglitz, 2010), does not prove to be valid. Growth was never taken as a measure for detecting progress, instead it is considered as an instrument for gauging generation of income. The new economic paradigm is applied in order to facilitate a shift in the framework from technological to political perspective, which is new to economic systems. In mid-twentieth century, it was identified that the economic paradigm had been characterized by affordable and accessible credit, mainly in the open markets (Stigler, 1968).  Over the decades, debt has been regarded as an efficient method for raising fund and improving the asset values; but in a way, leverage of the companies had also increased.  The stronger dollar had dominated the equity and debt transactions. By employing the open market principles, capital markets had adopted self-correcting techniques, thereby minimizing the need for stricter regulation. Debt and open markets had generated incessant economic gains. However, from an economic point of view, formation of a new paradigm was deemed necessary in order to improve the situation. The new paradigm suggested that the global economy had failed to apply the regulations properly, which had in turn caused a number of financial scandals and bankruptcies over the decades. The debt was overused and a severe fall in dollar value was noted as the currency became dominant. Hence, the new paradigm will aim at abolishing the economic instability and losses by way of structuring economic power worldwide (Etzioni, 2002). It is too premature to claim that characteristics of the new economic paradigm are quite adequate in supporting development of the global economy. Even so, the new paradigm will be able to consider expanded function of the newly developed international markets and will be regarded as one of the main players in the economy. It will also consider improved role of the government in regulating the international and domestic trade and commerce. The simple use of equity and debt will be introduced in the financial markets so as to ease the process of financial transaction in the securities market as a whole (Robertson, 1999). The new paradigm will bring about a shift in the existing one by modifying the assumptions made and subsequently change the process wherein a system logically works.  Hence, the new paradigm will be an attempt made to explain the present economic crisis as well as a range of treatments required for directing the economy towards stability. It can be stated that monopoly existing in new consumer markets, such as, China and Eastern Europe, has increased investment made in foreign denominated securities. This event has escalated the demand for underlying assets as well as extended the role of regulatory authorities and governments in these markets. All abovementioned facts form components of the new paradigm. The benefits of the paradigm shift can be explained and justified, but the critics have mentioned that the change will not entail appropriate solutions for the economy to become stable. They have exclaimed that time will certify whether the new paradigm is able to bring about any change or benefit to the global economy. According to Scott (2014 cited in Stiglitz, 2010), there is a need for fresh conceptual framework, which can inspect the reasons for collapse of the old paradigm. He has suggested that the term, paradigm, can have several meanings, but the main perspective is as follows: Understanding: A particular paradigm provides new solutions to the existing problems, which the prevalent paradigm failed to address. Action: A new paradigm should utilise the existing investigatory techniques and tools for testing usefulness of the same. Vision: The new paradigm will aim at providing improvised investigating approaches that lead to a number of novel directions within the framework (United Nations Headquarters, 2012). Scott has also identified the fourth characteristic of a new paradigm or communicability. The new paradigm should communicate its message to the individuals. It may not follow inclusion or introduction of new terminologies, but visualization is important. The general public should understand the same message and accept the paradigm shift. Apart from a general definition of the concept, Scott (2009 cited in Stiglitz, 2010) also recognised the need for a new paradigm and subsequently highlighted on areas that should requires being in order to facilitate positive changes in the economy. He had explained the following perspectives in order to elaborate on the concept as per his understanding: Limits to growth: It is worth mentioning that the main focus is directed at growth in the industrial sector for decades, which is why growth is limited and are directed by the policy makers and politicians. Hence, over the years, growth has become a constraint factor in every economy, which must be altered to instil stability globally. These constraints are attached to the existing mainstream models that have become obsolete in the present scenario. It is anticipated that the new paradigm will address to this problem and transform the constraint into the most beneficial factor. Inter-temporal needs: The unique characteristics of every human being are that they are wise and have the capability to formulate and appropriately implement long run strategic plans. Such capabilities are facilitated when an individual has adequate material resources in order to sustain in future. If such resources appear to decline, an average person is unable to cater to needs of his family members and descendants. The material resources are depleting at a fast pace and needs of the individuals remain unsatisfied. The present economic paradigm will aim at addressing these issues by way of adjusting the future discount rate. Hence, a new economic paradigm will be able to cater to needs of the future generation more specifically and implicitly (Shaffer and Wright, 2010). New economy initiatives: In the present economy, there is considerable rise in the economic initiatives, which is based on the cooperative principles. The existing economic paradigm could not rightly analyse these principles as it considered competition as the main drive for human economy. Consequently, a new paradigm will take into account competitive forces as the social dynamic model. Definition of capital and wealth: Over several decades, Gross domestic Product (GDP) has appeared to be a weak metric for gauging productivity and wealth of a particular economy. Owing to this reason, multiple alternatives have been formulated such as, Genuine Progress Indicators (GPI) and Global Reporting Initiatives. Currently, there is need for implementing these options (Etzioni, 1998). Such alternatives will form part of the new economic paradigm that will comprise the tools for measuring the building blocks both quantitatively and qualitatively. Organisational Transformation: Although the new economic initiatives are quite significant for facilitating development of the economy, they have been unable to contribute as expected. These initiatives did not explain the theory behind rapid transition, rather advocated undertaking practical means for accomplishment of the tasks. So, it is expected that the new economic paradigm will consider the theoretical perspective behind rapid transition of the existing production-oriented structure based on the cooperative principles. According to Scott (2009 cited in Stiglitz, 2010), there is a need for new economic paradigm that can support economic development, thereby leading the global economy towards a new future. Nonetheless, his ideas are questioned by many researchers and economists. Drechsler, Kattel and Reinert (2011) criticized the ideas presented by the author and argued that the new paradigm will greatly add to the cost incurred by the governments and individuals in the developing countries. They also stated that specified variables for the change are difficult to address as they are related to the economic agents. These agents are cannot be modified easily as huge investment is required (McDaniel and Driebe, 2005). According to Stiglitz and Greenwald (2003), since Great Depression, the blame game had continued in order to identify the one responsible for the worst recession to have ever occurred. The financial managers as well as the audit firms were accused primarily for conducting fraudulent activities related to financials of the companies. They even failed to predict risks that the companies had later encountered, leading to bankruptcy and worse economic conditions. The regulatory authorities were unable to prevent such incorrect activities. The economic models were misused causing market prices of the companies to slump. As a result, the shareholders had to face huge loss. Presently, the economy had shambled to a great extent, thereby creating the need for a new economic paradigm. This new paradigm is expected to revive the global economy from the current position. The authors explained that it is difficult for the non-economists to determine peculiarity of the macroeconomic models. It is assumed that the demand created has to correspond with supply, which indicated presence of unemployment. Representative agent’s model was employed by the individuals who were regarded as identical and thus, it can be identified that there was no meaningful financial markets. The authors highlighted on the fact that information asymmetries were the cornerstone of an economy and information pertaining to the financial market was necessary (Cosman, 2010). Over past few decades, the unsuccessful models had appeared to bring about ineffective policy. For instance, the central bank concentrated on inefficiencies present in the small economies, which appeared due to inflation. Besides those inefficiencies, there were other events that had highlighted the fluctuations in asset prices and dysfunctional financial markets. These models elaborated on efficiency of the financial markets. However, the standard macroeconomic models did not include adequate analysis of the banks. According to Alan Greenspan, the former Chairperson of Federal Reserve, the banks did not perform their duty adequately in respect of risk management. Alan exclaimed that the banks should have predicted the short-term risk after considering behaviour of the economy. The standard models should have been ranked according to their ability to predict risky circumstances. These models could have increased ability of the banks to forecast risk in times of uncertainty such as, recession and financial crisis. The models failed to depict actual results and assumptions made by the policy makers had sabotaged credibility of the banks. The policy makers were unable to foresee the crisis that took place after bubble burst and wrongly imagined that the effects would be minor (Hall, 1993). Criticising the views of Stiglitz and Greenwald (2003), Bentham (2007) stated that the flawed models had generated several economic issues as strategies implemented had failed to detect the risks in financial markets. He confirmed that many researchers did not follow the models while evaluating the economic condition, instead they engaged in developing new alternative approaches. The economic theory had identified that the standard models were not robust in reality, thereby implying that small modifications in the assumptions had led to huge changes in conclusions drawn based on the model. Minor asymmetries in information or imperfections in evaluating the risky condition of financial markets had highlighted that the latter was not cost efficient. The celebrated result of Adam Smith’s invisible hand was also not accepted by the economy. The invisible hand remained hidden as it was absent. In the present scenario, none will accept the fact that the bank managers have focused on improving the economic condition by avoiding their self-interest. The monetary policy affected the global economy through its credit availability and associated terms and condition, which were followed in order to make the credit available to the small and medium sized enterprises (SMEs). For understanding requirements of the SMEs, the banks had analysed the sector through the shadow banking methods. The spread between the lending rates and Treasury Bill rate changed drastically. Other than few exceptional banks, most central banks worldwide did not stress on the systemic risk. As a result, the credit inter-linkages became volatile. In the past, many researchers had tried to assess issues such as, the possible reason of bankruptcy. Such issues played an important role in causing the financial crisis encountered by the global economy in 2007 (Barry, 1978). The economy could not ascertain a perfect model, which was greatly needed. The standard models should have carefully recognised the complex relations between different change agents of the economy such as, companies and households. The connections could not be studied in such models, where every individual was predicted to be the same. Even the gloomiest part of assumptions pertaining to rationality was criticized. Systemic deviations were observed in rationality and these affected the macroeconomic behaviour. As a result, there was an urgent need for a new economic paradigm, which can safeguard all abovementioned issues and make the assumptions valid in reality (Barry, 1978). Though a paradigm shift is needed, yet the sudden change cannot be facilitated easily. The existing paradigm has been constructed by investing huge amount of money. So, it is not wise to make a shift that will require even larger amount. Regardless of this difficulty, it is possible to employ a new paradigm as there is an urgent need for improving the global economic condition. The intellectual scholars have devoted their time towards developing a new framework that can suit the economy. These scholars are assisted by a number of researchers who have adequate knowledge regarding the paradigm shift issue. These individuals are collectively striving towards creating a new paradigm. Hence, the idea of creating a new economic paradigm is encouraged by scholars around the world. Yet, the government and higher authorities have questioned the framework as it will entail a huge investment, which is difficult to afford for several developing countries (Barry, 1978). Conclusion From the above discussion in the literature, it can be concluded that a new economic paradigm is greatly needed to improve the global economic conditions. The global economy is subject to several changes pertaining to environmental, socio-cultural and political aspects. Amidst all such changes, the economy had tried to revive its position from the past few decades by employing the standard models. However, these models were unsuccessful in bringing about any development in the global economy. Consequently, establishment of a new economic paradigm is very necessary. Reference List Barry, B., 1978. Sociologists, Economists and Democracy, Chicago. Chicago: University of Chicago Press. Bentham, J., 2007. An introduction to the principles of morals and legislation. New York: Dover Publications. Cosman, D., 2010. Sustainability Through A New Economic Paradigm For The 21st Century. [pdf] n.p. Available at: < http://www.eartheconomics.org/FileLibrary/file/Reports/Sustainability_through_a_New_Economic_Paradigm.pdf > [Accessed 2 August 2014]. Drechsler, W., Kattel, R. and Reinert, E., 2011. Techno-economic paradigms. London: Anthem Press. Etzioni, A., 1998. The moral dimension: Toward a new economics. New York: Free Press. Etzioni, A., 2002. Social Norms: The Rubicon of social science: The Monochrome Society. New Jersey: Princeton University Press. Hall, P. A., 1993. Policy paradigms, social learning, and the state: the case of economic policymaking in Britain. Comparative Politics, pp. 275-296. McDaniel, R. and Driebe, D., 2005. Uncertainty and surprise in complex systems. NewYork: Springer. Reza, N., 1999. Islamic Economics as a New Economic Paradigm. [online] Available at: < http://conference.qfis.edu.qa/app/media/259 > [Accessed 2 August 2014]. Robertson, J., 1999. New economics of sustainable development: A briefing for policy makers. New York: Palgrave Macmillan. Shaffer, D. and Wright, D., 2010. A New Paradigm for Economic Development. [pdf] n.p. Available at: < http://www.rockinst.org/pdf/education/2010-03-18-A_New_Paradigm.pdf > [Accessed 2 August 2014]. Stigler, G., 1968. Competition: International Encyclopaedia of Social Sciences, Macmillan, 3, pp. 181-2. Stiglitz, J. and Greenwald, B., 2003. Towards a new paradigm in monetary economics. Cambridge: Cambridge University Press. Stiglitz, J., 2010. Needed: A New Economic Paradigm. [online] Available at: < http://www.ft.com/intl/cms/s/0/d5108f90-abc2-11df-9f02-00144feabdc0.html#axzz392vohNRp > [Accessed 2 August 2014]. United Nations Headquarters, 2012. Defining a New Economic Paradigm. [pdf] United Nations Headquarters. Available at: [Accessed 2 August 2014]. Read More