The useful economic model is that which works
The Central Bank of Kenya's head office in Nairobi. CBK has been raising interest rates in an effort to contain inflation. But if the inflation is caused by the war in Ukraine, raising interest rates only serves to hurt Kenyans, who now have to pay 18 per cent on their loans.
Economic theories come in pairs at a minimum, but often in larger multiples.
This has prompted a popular tale of the king who, frustrated, asked for a one-handed economist. He wanted to rid himself of the confusing advice, which would start on the one hand, and change track mid-way to end on the other hand.
Being of the two-handed variety, I will classify economic theories as classical, or neo-classical. Classical theories describe things as they are. Neo-classical theories describe things as they should be. Debate on which is the better type was settled, in favour of the neo-classicals, in the following manner.
Suppose during the holidays you went by the local pool hall. You might be an aspiring politician, or just a good Kenyan, spreading the holiday cheer. You find a dozen young men playing pool, and the local champion is on.
You observe him using the cue to strike the white ball, which in turn strikes the black ball in the middle of the pool table, bouncing it off the edge, to pocket it in the opposite corner, much to the delight of those who have bet on him winning.
As an astute intellectual, you can describe what he is doing using complex mathematical equations, involving vectors, moments, velocity, angles, momentum and so on. But it is unlikely that the young man studied high school calculus. Yet as he prepares to unleash the cue, eyeing the angle of attack with intensity, practising the strike as if to measure the speed and force to use, he only needs to act as though he is solving the mathematical equations!
Stimulate economic activity
If a theory works, it is a good theory. To paraphrase Deng Xiaoping, colour notwithstanding, the good cat is the one that eats mice. It is an important characteristic because the interplay between economics and politics is often an article of faith. The usefulness of a theory is its policy prescriptions. What is a government to do when inflation is rising? How do you stimulate economic activity to create jobs?
Obviously, if your theory doesn’t work, or only works sometimes, you can be in real trouble. Markets only work if consumers have perfect information. Yet we know that even in this age of higher access to information, most of us will miss it when it is staring at us straight in the face.
Take the cost of credit. Banks are required by the Central Bank to show customers the total cost of credit, to make it possible for customers to compare. Since the cost-of-credit calculator is available as an app, you would think that we all have it. Well, only about 1,000 have downloaded this tool!
Meanwhile, in keeping with the theories, CBK has been raising interest rates in an effort to contain inflation. But if the inflation is caused by the war in Ukraine, raising interest rates only serves to hurt Kenyans, who now have to pay 18 per cent on their loans. A better policy would be to stimulate local production to replace what we are importing.
The theories tell us that demand creates supply. Yet as animals were dying in drought-stricken Kajiado, Laikipia and throughout northern Kenya, MV Banyas 1, a livestock carrier, was berthed at Lamu, looking for livestock for export.
As Kenyans struggle for food in the north, there is plenty in the Kavirondo gulf. Fresh produce markets in Ol Kalau and Nyahururu are full, but 100 kilometres north, households are in need of food relief.
Moral of the tale? Our economic managers must abandon dogma. Forget what the theory says. Do what works.
@NdirituMuriithi is an economist
