Atlantic Correspondent Richard Posner has good piece out this morning about British economists trying to explain to the Queen why economics failed so miserably to predict the financial crisis. He suggests, as many others have, that economists must admit they don't know everything when it comes to business cycles, and should refocus their efforts so to learn from their mistakes here. I think he's right, but I worry it won't help much.
Back in college I took a rather wonderful approximately graduate-level seminar called "Economics Meets Science Studies." The main purpose of the course was to examine the question of whether economics was more of a hard science or social science. By the end of the semester, I found the argument that economics was more like physics than anthropology completely unconvincing. (Though the course, ironically, counted towards my physics major, not my economics major.)
This view would anger many economists. Most generally believe that their discipline is more than a mere social science. After all, it involves lots of fancy math -- just like physics and chemistry. It also doesn't appear to involve as much mere documentation and interpretation as something like history. They believe that economic theory can use real world assumptions to derive legitimate predictions. I think they're right about very simple questions, but the more complex the system, the more I believe economics just fails.
It might be sacrilegious for me to admit this, but I am wholly unconvinced most macroeconomic theory can ever hope to make consistently accurate predictions. There are entirely too many variables, and people just aren't as rational as economists like to assume they must be. Here's an excerpt from Posner's piece that begins to touch on this assertion:
This failure was I think due in significant part to a concept of rationality that exaggerates the amount of information that people have about the future, even experts, and to a disregard of economic factors that don't lend themselves to expression in mathematical models, or are intractable to formal analysis.
That's true, but I'd take it a step further: the concept of rationality even exaggerates rationality. Even with good information, people often make stupid decisions based on emotion. I would even argue that generally people are more emotional than rational -- and that's a huge problem for modern economics.
I don't know I can think of a better example of emotion taking over than bubbles. They exemplify irrational exuberance. Investors get excited that there's a fortune to be made and inflate prices. Eventually, they begin to realize prices are too high, and then they panic, sometimes even driving prices too low. Market value says little about the rational price of a good, just what people feel that good is worth.
The real estate bubble wasn't a problem of investors not being able to obtain adequate information. They could have demanded more information, but they didn't think they needed it. They let their emotion through excitement carry them away, rather than allow their cool, rational side to request more information. Unfortunately, no math is advanced enough to model emotion.
Don't get me wrong: I don't think economics is doomed to be classified as a waste of time. I think economists do some very important, often valid work. But so do meteorologists. In both disciplines, it's easy to make broad claims that turn out to be generally correct based on probabilities. But just how sometimes meteorologists predict clear skies only to look foolish when it rains, economists may incorrectly predict good economic times that turn out to be very bad.
There's no question that macroeconomists have learned a lot over the years. But there's also no question that they have more to learn and can never hope to know it all. As a result, you cannot possibly expect them to be perfect, but should merely hope that they do more good than harm. I think their work in helping to dampen the blow of the financial crisis shows that, even though they got it wrong to begin with, their research helped to prevent another Great Depression. Through their failure, some success for the discipline cannot be denied.
GREAT blog, and spot on.
It's a hard science. Economics is where cash accounting meets psychology. Unlike History both of those (thanks to Quicken and advances in neural imaging) can be observed and tested experimentally.
It's true that people make decisions emotionally, but that doesn't mean we can't measure that and form hypotheses.
I commented on Richard Posner's blog; but Daniel Indivglio is too forgiving to us economists for our own good.
First, we have not yet 'prevented' another Great Depression. Our best guesses all say that another Great Depression is now unlikely; but not impossible.
Second, the most likely prospect for most of the developed world is years of high unemployment and a generation of higher taxes than we used to forsee (provided the Chinese Communists do their bit and boost domestic demand; otherwise it is worse). With hindsight, some of that damage was inevitable; but much of it could have been headed off by timely economic policy action (not juat in the USA).
Third, it is open to debate about how much mainstream formal macroeconics has learned. If you advance your discipline through thinking through how multiple features of the economy might work; then model those ideas to get the best fit you can with the existing data; the only data which can reinforce or confound your model is in the future. You have actually learnt nothing until the future comes to pass.
But the profound trouble is that few of us try to find real world data which casts doubt on our theories. That is what science requires. Without that laborious touchstone of truth, we are doing little more than analysing moonbeans in Laputa.
On day one of Econ 101, our professor told us within two minutes something I shall always remember:
"Economics is a language, not a science. It is used to precisely describe things that have happened in the past, not to precisely predict the future."
The big problem I see with economics is that it tries to measure what people have done in order to guess what they will do. But since people will see the results of the research and theorizing, they will modify their behavior to take advantage of either the models or overgeneralized conclusions from the models. This goes along with human beings' efforts to game every other system they come across, and good thing too or we wouldn't have done the wild things that have brought us so far from the cavemen of yore. When economics successfully describes and predicts everything we do, it will be because we have stagnated, not because economics has been perfected.
The economists have not "prevented" another depression. If you say that, then virturally the whole purpose of your article is negated.
There were more than a few economists who saw the banking meltdown coming, though their warnings were largly marginalized. Because of the human element, the reality that macroeconomics attempts to model becomes incredibly complex. Climatology, considered to be a hard science, also attempts to model a hyper-complex system. When the Global Warming majority of the field were proven wrong and switched their focus to anthropomorphic climate change, they were given a free pass (the new theory is still far from proven). If economics is to be "downgraded" to a soft science because the majority of it's practitioners failed to build a predictive model of the vastly complex system, should not the field of climatology face the same fate?