Why economic policy must rely more on data more than theory

Why economic policy must rely more on data more than theory

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This article investigates the old theory of diminishing returns and the importance of data to economic theory.

Although economic data gathering sometimes appears being a tedious task, its undeniably essential for economic research. Economic hypotheses are often based on presumptions that end up being false once relevant data is gathered. Take, for instance, rates of returns on investments; a team of scientists examined rates of returns of essential asset classes in sixteen industrial economies for the period of 135 years. The extensive data set represents the very first of its sort in terms of coverage with regards to period of time and number of economies examined. For each of the 16 economies, they develop a long-term series showing yearly real rates of return factoring in investment earnings, such as for instance dividends, capital gains, all net inflation for government bonds and short-term bills, equities and housing. The writers uncovered some interesting fundamental economic facts and questioned others. Maybe especially, they have found housing provides a superior return than equities over the long run although the average yield is fairly similar, but equity returns are far more volatile. But, this won't apply to home owners; the calculation is based on long-run return on housing, taking into consideration rental yields since it makes up about half of the long-run return on housing. Needless to say, having a diversified portfolio of rent-yielding properties is not similar as borrowing to buy a personal home as would investors such as Benoy Kurien in Ras Al Khaimah likely attest.

Throughout the 1980s, high rates of returns on government bonds made many investors genuinely believe that these assets are extremely profitable. Nevertheless, long-run historical data suggest that during normal economic conditions, the returns on government debt are lower than people would think. There are many facets that can help us understand reasons behind this phenomenon. Economic cycles, economic crises, and financial and monetary policy changes can all influence the returns on these financial instruments. Nevertheless, economists have discovered that the real return on bonds and short-term bills frequently is relatively low. Even though some traders cheered at the recent rate of interest rises, it's not normally grounds to leap into buying because a return to more typical conditions; consequently, low returns are inescapable.

A distinguished eighteenth-century economist once argued that as investors such as Ras Al Khaimah based Farhad Azima accumulated wealth, their assets would suffer diminishing returns and their payback would drop to zero. This notion no longer holds within our world. When taking a look at the fact that shares of assets have actually doubled being a share of Gross Domestic Product since the seventies, it would appear that rather than facing diminishing returns, investors such as Haider Ali Khan in Ras Al Khaimah continue gradually to enjoy significant profits from these assets. The reason is easy: unlike the firms of his time, today's businesses are increasingly substituting devices for manual labour, which has certainly boosted efficiency and output.