Wednesday, January 25, 2012

Fixing Economics

Robert Johnson has a few suggestions, below (HT - Mark Thoma). Regular readers know I think some of the sob stories about the "state of economics" are overblown. The two examples that Johnson leads with in the article (the Queen asking why economists "didn't see it" and the Mankiw walkout) are particularly irrelevant points. The Queen shouldn't expect anyone to be able to forecast a complex system, and the Mankiw students were being very naive.

Nevertheless, there's some really good stuff in here. I think the third point is probably already inculcated by the discipline, but the others - particularly the first - are very good.

One of the problems is that reading the first suggestion, I know different people will have different culprits in mind.


"First, economists should resist overstating what they actually know. The quest for certainty, as philosopher John Dewey called it in 1929, is a dangerous temptress. In anxious times like the present, experts can gain great favor in society by offering a false resolution of uncertainty. Of course when the falseness is later unmasked as snake oil, the heroic reputation of the expert is shattered. But that tends to happen only after the damage is done.

Second, economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation. Nobel laureate Kenneth Arrow saw this danger years ago when he exclaimed, “The math takes on a life of its own because the mathematics pushed toward a tendency to prove theories of mathematical, rather than scientific, interest.”

Financial-market models, for instance, tend to be constructed with building blocks that assume stable and anchored expectations. But the long history of financial crises over the past 200 years belies that notion. As far back as 1921, Frank Knight of the University of Chicago made the useful distinction between measurable risk and “unknown unknowns,” which he called radical uncertainty. Knight’s point was that in a period of radical uncertainty, expectations couldn’t be anchored because they have nothing to latch onto. Financial theories and regulatory designs that hinge on the assumption of stable and anchored expectations are not resilient enough to meet the challenges presented by real financial markets in radically uncertain times. [See Keynes on unknown unknowns as well]

The third remedy for repairing economics is to reintroduce context. More research on economic history and evidence-based studies are needed to understand the economy and overcome the mechanistic bare-bones models the students at Harvard objected to being taught.
But the economic orthodoxy continues its romance with the Enlightenment tradition of Cartesian “universal laws.” This began after the Thirty Years’ War, when society demanded both a method of investigation that did not antagonize religious factions and universal abstract laws and principles that could be objectively proven. Lost to the traumas of religious and social turmoil were the humble and pragmatic humanistic approaches of Francis Bacon and Michel de Montaigne and the suppleness of William Shakespeare. Reorienting economics away from the Enlightenment glamour of high theory and returning it to focusing on real problems, in the same way a clinical physician does, would make economics more relevant.

The profession needs to realign the incentives for doing reputable research in order to protect its integrity as a whole, as is done in medicine. Recent policies announced by the American Economic Association on disclosing conflicts of interest are a step in a healthy direction. Faculty members should also be forced to step down from consulting at the time they receive tenure.
Fourth, we must acknowledge the intimate, inseparable relationship between politics and economics. Modern debates about who caused the financial crisis—­government or the private financial sector—are almost ­nonsensical. We are living in an era of money politics and large powerful interests that influence the laws and regulations and their enforcement. In order to catalyze the evolution of economics, research teams would benefit from multidisciplinary interaction with politics, psychology, anthropology, sociology and history.

Such interdisciplinary communication would also benefit another neglected area of economics: the study of macroeconomic systems. Psychologists mock what economists call the micro­foundations of consumer behavior—a set of assumptions based on the idea that isolated individuals behave with clear knowledge of the future. That this framework is suitable for aggregate systems in a globalized economy simply because the tribe called economics has agreed to adhere to these ad hoc assumptions makes no sense. Increased interactions with disciplines that economists have often mocked as unscientific would greatly improve economists’ understanding of the real world and would be more truly scientific."


  1. There are some very good points in here - the cricism of maths, acknowledgement of uncertainty and recognition of the importance of history. However, for me, this sentence is more valuable than all of the others:

    'Modern debates about who caused the financial crisis—­government or the private financial sector—are almost ­nonsensical.'

    Yes x1000. This is an implicit recognition of so much of the cognitive dissonance that neoclassicism can create.

  2. Of course I am unable to agree for too long, so:

    'The Queen shouldn't expect anyone to be able to forecast a complex system'

    It's not about accurate forecasts it's just that economists were looking in the wrong place. Had they acknowledged the role of private debt in the system alarm bells would have been going off years before the crisis.

    Also the dismissal of the Mankiw students is unfair - sure, they're just first year UGs but that doesn't mean they are unable to evaluate the end product of economics (financial crises). If buildings kept falling down for no reason I'd certainly back a first year boycott of civil engineering.

  3. The Queen shouldn't expect anyone to be able to forecast a complex system.

    Really? Then what's the bother?

    And, of course Lucas did and so did Greenspan and both still have their licenses.

    In fact, the "profession" is rotten to the core, with tenure, conflicts of interest, and bias and prejudice and lots of wackos. What other science would tolerate "libertarians?" See The Onion (passim).

    The 800 pound gorilla is, of course, private debt, two words which never pass your lips. And the reasons are obvious. The only solution makes "class warfare" look like a picnic and who would dare offend the Rich who hold all the debt that just needs to be cancelled.

  4. Also note the use of the term 'complex system' yet the refusal to part substantially from GE and PE models!

  5. It's things like this that make me wonder if the economics profession should take the econophysicists more seriously, lest everyone gets overtaken and falsified into oblivion as Joseph L. McCauley predicts...


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