Economic theory

"The Paranoid Style in Economics"

Jonathan B. Wight

Raghuram Rajan looks back at the exchange between Paul Krugman and Carmen Reinhart and Kenneth Rogoff.  He wonders:

"Why do high-profile economic tussles turn so quickly to ad hominem attacks?"

Part of the answer is in the unsatisfactory results from empirical work, especially in macroeconomics. It is hard to say much with certainty.

Pundits won’t get many readers with wishy-washy conclusions, so the natural tendency is to fudge—by professing more certainty than the data would warrant.

Another aspect has to do with the verbal attacks (and physical threats) on Krugman, which have made him more than a little defensive. The old joke goes, “Just because you’re paranoid, doesn’t mean they’re not out to get you….”

We all say things in the heat of the moment that best not have been said.  Hard to remember, but virtue ethics asks us to be humble, to be temperate, and to forgive.  Where are these attributes in the economics research manual? 

How to Stop "The Death of Economics"

Mark D. White

Recently, at The Weekly Standard, David M. Smick opined in a piece titled "The Death of Economics" on the decline of the field over the last 50 years, focusing on the last decade in particular and the increasing hubris among policy-oriented economists:

For decades, hubris has been the common currency of the economic policy world. It is killing the economics profession. In the 1960s and 1970s, for example, liberal economists believed they could eliminate all poverty. In the 1980s, conservatives thought tax policy could permanently raise the savings rate. It turns out other factors also influence a person’s decision to save.

In the first decade of this century, some central bank economists thought they could engineer monetary policy (with the help of global capital inflows) to eliminate the U.S. business cycle. What happened? The underpricing of financial risk helped lead to the global financial crisis.

After outlining the perilious state of the world economy (for those who haven't noticed), he asked some probing questions, such as how we can know when much debt is too much debt; how we can hope to understand entrepreneurship and its relation to regulation; and how we can stop making "the little guy in America the permanent fall guy." He concluded:

An economic policy rethink won’t be easy. But the first step is to deep-six the hubris. This year should mark the death of all government five-year economic forecasts.

I agree, as I've written before. As Smick stated in the beginning of his piece, a five-month forecast might be reasonably accurate, but a five-year forecast... fuggedaboutit.

But I found this statement from the middle of the piece more intriguing:

So at worst, the field of economics is dying. It is becoming less a science and more an art.

Let's not go that far... yet. Economics is dying only if one conceives of it as a science like physics in the first place. If one doesn't, however, one can see economics emerging from this internal crisis a more holistic, thoughtful—and yes, ethical—discipline.

  • An economics which doesn't purport to understand and model the entire economy in precise quantitative terms (reflecting the hubris Smick decries), but one which uses sound qualitative judgment, based on experience, to move economic indicators by small increments in the desired direction, reflecting improvement in people's lives.
  • An economics that doesn't claim to have "the solution" to a crisis, but has a good idea what to do to get there (in the sense described above).
  • Finally, an economics that will assess its own progress and will admit when the first choice of action has failed and it needs to move to the second one.

If economics were reconceptualized along these lines, it would resemble neither science nor art, but rather practical philosophy—which, after all, is how it all started. While economists trained in the current quantitative, positivistic paradigm would resist it, I believe this approach to economics would recapture people's faith in its predictions and recommendations—in no small part based on its humility rather than hubris.

"Should We Trust Economists?" Yes and no.

Mark D. White

The worst thing to do when I'm trying to write is have Twitter open. Not only is it distracting (obviously), but it can be positively engrossing. So why do I do it? Because it helps me keep me up-to-date on the state of the world and what smart people are saying about important things.

In the last hour, I've seen two articles that pose questions, which I'll take a shot at answering—please feel free to offer your own answers in the comments below.

Question: "Should We Trust Economists?" asks Noah Smith in The Atlantic.

Answer: Yes, but with serious qualifications.

Smith recounts some familiar and valid criticisms of economics and economists, largely focusing on the limitations of economic models and the lack of experimental data with which to test them. He falters, though, when he dismisses alternative approaches, such as Austrian economics, and in a particularly infantile and insulting way. (I'll leave it to my friends at Coordination Problem to address this if they choose.) Except for that piece, Smith gets a lot right. I'll just mention two reservations that Smith fails to address:

a) Economists have a strong ideological and political bent, which consciously or unconsciously influences their work. This may be true of all scientists and researchers, of course, but the arbitrary and heuristic nature of many assumptions in economic models grants economists a great deal of discretion to insert their values and beliefs in their "scientific" models. So when an economists says "my model recommends stimulus" or "my model recommends austerity," keep in mind that this is not an entirely objective statement—nor can it be.

b) Somewhat related to the first point, economists are much better at saying what will happen than what should happen (and that's true even if you're very doubtful about how well they know the former!). When economists say what should happen—that is, what the government should do or what society should aim for—they're assuming a certain goal which is not an economic concept but an ethical or political one, about which economics training lends little specialized insight. So to the extent we should trust economists, we should trust them to recommend ways to get different places, leaving it to our elected representatives, acting through us, to decide where we want to go. (Or, ask a philosopher!)

So should we trust economists? Yes, if we restrict and temper that trust to focus narrowly on what economists do best—trace out the implications of various actions for key economic variables—and keep in mind the limitations of their prescriptions, based on both the limitations of economic science and the inherent ideology of economic models.

Question: "The question libertarians just can't answer," which is: "If your approach is so great, why hasn’t any country anywhere in the world ever tried it?" This comes from Michael Lind at Salon.

Answer: Many reasons, but the most important one is probably the temptation of power and the wealth it artifically creates, which libertarianism minimize. Even if we want to take a more optimistic approach, then I would cite the presumption of some people to think that a) they know what is better for other people and b) they have the right—nay, the responsibility!—to impose this better way of life on them. This is temptaton of a different sort, born of beneficence but grounded in hubris and disrespect. (I trust Bleeding Heart Libertarians will have more to add to this before long!)

Two book reviews in economics and ethics from the Erasmus Journal for Philosophy and Economics

Mark D. White

Thanks to the indispensable Heterodox Economics Newsletter (latest issue here), here are two recent book reviews that may interest our readers, both from the latest issue of the Erasmus Journal for Philosophy and Economics (6/1, Spring 2013). [In the interest of full disclosure I must note that I blurbed the first book and the second was published in my "Perspectives in Social Economics" series from Palgrave Macmillan.]

Economics_as_applied_ethicsEconomics as Applied Ethics: Value Judgements in Welfare Economics, by Wilfred Beckerman (Palgrave Macmillan, 2011), was reviewed by our own Jonathan B. Wight, who finds it "a well-written textbook geared to advanced undergraduate or graduate students of economics, many of whom are largely and regrettably innocent of the ethical problems inherent in conventional economic analysis." After a detailed critical breakdown by chapter, Wight concludes that:

Overall, this book is highly recommended. It covers the selected topics with depth and sensitivity. The writing is generally excellent, but there are occasions of repetition and unevenness, as if the chapters were compiled separately and merged later. A student reader who is not already familiar with basic ethical theories could benefit from a primer in some places. For example, the book discusses Amartya Sen’s theory of commitment, however it does not dig very deeply to explain or defend that notion, whether from a deontological or virtue ethics approach.

The book devotes a lot of attention to questions of equality and justice, particularly on the work of economist philosophers such as John Broome, Partha Dasgupta, Ian Little, and Amartya Sen. This is
appropriate, interesting, and relevant. However, the book does not appear to address research in experimental economics, biology, and psychology that might be relevant to some of these questions, such as the work in neuroeconomics by Paul Zak, experimental work by Vernon Smith, or recent philosophical work on virtue ethics by Deirdre McCloskey. This is the normal limitation of any text that strives to be concise, yet students should understand there is much more to ethics and economics than can be conveyed in this book.

Approx_prudenceApproximating Prudence: Aristotelian Practical Wisdom and Economic Models of Choice, by Andrew Yuengert (Palgrave Macmillan, 2012), was reviewed by Ricardo F. Crespo. According to Crespo, 

Yuengert shows in this book that economic modeling undertakes only a partial analysis of economic action, because it ‘puts away’ interesting features of its subject that deserve to be taken into account. He proposes adopting the Aristotelian account of human action—more specifically, of practical wisdom—as the benchmark against which to consider economic modeling. He maintains that “economics can learn much about its limits from Aristotle, who describes aspects of choice behavior that cannot be precisely modeled” (p. 3). Thus, the aim of the book is to determine what aspects of human behavior cannot be captured by the economists’ models.

After a careful analysis of the book's structure and arguments, Crespo concludes that it

provides the useful service of identifying the characteristics of human action that economic models cannot take into account. It is useful because it explains the challenge to positive economists of trying to incorporate these characteristics into their approach, and because it highlights the features that economists must consider in their normative work. The contribution of the book lies in its originality. Economics books are not usually about what economics cannot do.

Both the author and the reviewer are Aristotelian economists, and readers benefit greatly from Crespo's detailed analysis of Yuengert's use of concepts such as eudaimonia  and contingency (the latter is comparison to Knightian uncertainty). (See Crespo's page for his own work on Aristotle and economics.)

Our Children’s Economics

Jonathan B. Wight

What is the future of economics? Barry Eichengreen posted his ideas in "Our Children's Economics" in The Economist.

According to one view, the economics of 2030 will have marginal improvements, adding a bit of behavioral economics here, a spice of institutional theory there, perhaps even a re-writing of Adam Smith's ethics and a reinterpretation of the invisible hand that is not based on greed.

Eichengreen argues that the marginalist view is likely wrong. We are heading for major rifts and breakthroughs, similarly to the Keynesian revolution of the 1930s. What these are he cannot say.

My own pet theory is that economics will merge with biology to make BIO-ECONOMICS. Both fields try to understand survival and procreation in particular habitats with innovation and adaptation to changing environments.

Eichengreen notes that the mechanism by which knowledge is transferred from generation to generation will radically change. The old model is of a great authority who writes a definitive textbook that lasts for a generation: think of Smith and Wealth of Nations in late 18th century, Ricardo and his Principles in the 19th century, Marshall's great fusion at the end of the 19th and early 20th century, and Samuelson's great synthesis of Keynesian economics in the 1950s and on.

In the future, Eichengreen argues that textbooks will no longer be written by big-name authors, but through a wiki-process, electronically built from the bottom up. The result will be different to be sure:

"The outcome will be messy. But the economics profession will also become more diverse and dynamic – and our children's economics will be healthier as a result."

[Thanks to Pam Thomas for this link.]

Has neoclassical economics led to ecological disaster?

Mark D. White Dr Barker

Here's an interesting and provocative talk, upcoming at the University of Greenwich on March 6, 2013 (register your place here):

"How Neoclassical Economic Thinking Has Led to Ecological Disaster?"

We are facing several crises at once: the near collapse of the world banking system in 2008 (and its consequences), the loss of biodiversity (the fifth extinction), world-wide pollution of land, water and air, and apparently escalating climate change. I shall discuss how neoclassical thought has justified the actions and behaviours that have led to these crises. Traditional economics (i.e. neoclassical use of calculus, network and game theory) has an emphasis on individual utility, rationality and market equilibrium. This approach with the use of market discount rates, the lack of reflexivity, the conversion of altruism into money, and the absurd separation of issues of equality from those of economic growth and welfare, has turned people into commodities (in the theory), played down our love of nature, and coarsened those who teach it. The greed and self-serving behaviour of the global banks, and the clients they advise, demonstrates the end result of worship of so-called free markets and pursuit of deregulation to achieve more profits.

About the speaker:

Dr Barker is the Chairman of Cambridge Econometrics, having founded the company in 1985. He is also Senior Departmental Fellow at the Cambridge Centre for Climate Change Mitigation Research (4CMR), Department of Land Economy, University of Cambridge. He is a member of the Editorial Board of Economic Systems Research, the International Journal of Climate Strategies and Management, the International Journal of Global Warming, and the Scientific Advisory Board of the World Wide Views on Global Warming. He was a member of the Scientific Committee of the Climate Change Congress, Copenhagen, March 2009, and was on the Writing Team of the Synthesis Report of the Congress. He received the Distinguished Guest Lecturer Medal for 2008 from the Royal Society for Chemistry, Environmental Chemistry Group.

He was a Co-ordinating Lead Author (CLA) for the the Intergovernmental Panel on Climate Control (IPCC)’s Fourth Assessment Report, 2007, for the chapter on cross-sectoral mitigation. Previously he was CLA in the Third Assessment Report, 2001, taking responsibility for the chapter on the effects of greenhouse gas mitigation policies on the global energy industries. He was a member of the core writing team for the Synthesis Report Climate Change 2001. He contributed to the IPCC's Scoping Meeting for the Fifth Assessment Report, held in Venice 13-17 July, 2009.

From 2000 he instigated and worked on projects building a global E3 model (E3MG) with initial emphasis on modelling the E3 structures of China and Japan. Since 2004 he has been working as member of a UK Tyndall Centre project to develop E3MG as a 20-region world model, designed to analyse GHG mitigation policies under endogenous technological change. He is now leading the research of a team in 4CMR developing and using E3MG for studies of the decarbonisation of the global economy, funded by the Three Guineas Trust, one of the Sainsbury Family Trusts. In the 1990s he was appointed the Project Co-ordinator of the pan-European project developing and applying the E3 model for Europe (E3ME), partly funded by the European Commission, analysing energy and fiscal policies including the equity effects of environmental fiscal reform. Previously he was Principal Investigator on projects funded under the ESRC’s Global Environmental Change Programme ‘Developing an E3 model of the UK economy’ and ‘Greenhouse gas abatement through fiscal policy’; the independent evaluators rated the outcome of the first of these projects as an outstanding contribution to knowledge. He worked with Professor Sir Richard Stone, the Nobel Laureate, in the Department of Applied Economics, becoming the Director of the Cambridge Growth Project 1983-87, a team of 8-10 economists that originally developed the (MDM) structural model of the British Economy.

The Illusion of Mathyness

Mark D. White

KimmoKevin Drum at Mother Jones recently highlighted a new paper by Kimmo Eriksson (Mälardalen University and Stockholm University) published in Judgment and Decision Making titled "The Nonsense Math Effect" (7/6, November 2012). Here's the abstract:

Mathematics is a fundamental tool of research. Although potentially applicable in every discipline, the amount of training in mathematics that students typically receive varies greatly between different disciplines. In those disciplines where most researchers do not master mathematics, the use of mathematics may be held in too much awe. To demonstrate this I conducted an online experiment with 200 participants, all of which had experience of reading research reports and a postgraduate degree (in any subject). Participants were presented with the abstracts from two published papers (one in evolutionary anthropology and one in sociology). Based on these abstracts, participants were asked to judge the quality of the research. Either one or the other of the two abstracts was manipulated through the inclusion of an extra sentence taken from a completely unrelated paper and presenting an equation that made no sense in the context. The abstract that included the meaningless mathematics tended to be judged of higher quality. However, this "nonsense math effect" was not found among participants with degrees in mathematics, science, technology or medicine.

It's a short paper and well worth the quick read (or read Drum's post, which summarizes it well). Eriksson reports that humanities/social science readers tended to be enchanted by the irrelevant equations, with 60-65% rating the adulterated abstract higher, but economists are not broken out of that very broadly defined group (which only includes 84 people as it is). Given some (most?) economists' predilection for mathyness, though, I would not be surprised at some degree of unconscious bias for research that promises greater mathematical sophistication (though I assume any such bias would melt away once the paper was read).

But I think many other economists, especially heterodox economists who are more skeptical about the benefits of mathematical modeling, might go the other way. I know that when I read an interesting abstract and then skim the paper, my eyes glaze over when I hit math--not because it doesn't add anything to support the author's thesis but because I'm afraid it will leave out many things in the interest of abstraction and simplicity, such the very nonquantitative aspects of the model that I found fascinating in the first place! Some things must be left out of a model, of course, but these factors should be omitted because they are relatively unimportant, not because they're don't fit into the modeling framework.

As Eriksson writes in his introduction to the paper,

In areas like sociology or evolutionary anthropology I found mathematics often to be used in ways that from my viewpoint were illegitimate, such as to make a point that would better be made with only simple logic, or to uncritically take properties of a mathematical model to be properties of the real world, or to include mathematics to make a paper look more impressive.

He very well could have included economics in there as well--I'm curious if his exclusion of it was intentional or random. Gee, I'll bet we could model that...

Have economists ignored clinical depression?

Mark D. White

ScienceA recent issue of Science (October 5, 2012) is a special issue on depression, and senior editor Peter Stern's introduction lays out the reason for it (emphasis mine):

Depression is a devastating disease. It affects not only the directly afflicted but also the people around them, their families, and their closest relations. It indiscriminately hits all strata of society, no matter one’s intellectual background, age group, or economic situation. There are many cases of highly successful and widely admired individuals who have been struggling with depression for years. Unfortunately, for reasons we still do not fully understand, this condition has been on the rise over the past decades. Considering its impact on an individual’s quality of life and subsequently on the economy and society in general, gaining an understanding of what causes depression and trying to develop effective therapies is of utmost importance. Hence, this year’s Neuroscience Special Issue is devoted to different aspects of depression.

I've long wondered why economists don't look more at both the microeconomic and macroeconomic effects of clinical depression. (I'm careful to add the modifier "clinical" because economists do, of course, spend a lot of time thinking about depressions, Great or otherwise.) Behavioral economists identify, quantify, and model the cognitive biases and dysfunctions that affect the choices of the average person, but have not yet (to my knowledge) looked into how depression affects decision-making. As Dr. Stern recognizes, choices affected by depression--given reported high rates of incidence of the disease--have potentially tremendous economic effects, not only on personal well-being but also on market outcomes, aggregate economic performance, and government policy.

BeckThere are many theories of depression in psychology, but one that seems extraordinarily well-suited to incorporating the effects of depression into economic models of choice is cognitive psychology, as typified by the work of Aaron Beck. Beck maintains “the individual’s problems are derived largely from certain distortions of reality based on erroneous premises and assumptions” (Cognitive Therapy and the Emotional Disorders, p. 3). Examples of this negative thinking include: dichotomous reasoning (everything is either black or white, failure or success), selective abstraction (focusing on failures and glossing over successes), and overgeneralization (exaggerating the importance and incidence of failures). In economic terms, these have obvious effects on beliefs and preferences, the foundation of decisions in the mainstream model of choice.

Depressives also report a lack of motivation or "paralysis of the will" that makes them less likely to act decisively to further their goals. In the mainstream economic model of choice, this can be be regarded once again as a result of distorted perceived benefits and costs (downplaying the former and emphasizing the latter) which result in a bias toward inaction (or at least decisional inertia).

This is just one possible framework, and there are many others. I believe that behavioral economists could work within such a framework to refine the cognitive and conative effects of depression on decision-making. Behavioral economists have already told us that we're "presumably irrational"--now it's time to turn to the members of society who are "presumably depressed."

Which is "harder": social science or physical science?

Mark D. White

Yesterday, Kevin Drum at Mother Jones spoke up for social science following an editorial in Nature arguing against the NSF's proposed defunding of research in political science. Here's a bit of the op-ed:

Part of the blame must lie with the practice of labelling the social sciences as soft, which too readily translates as meaning woolly or soft-headed. Because they deal with systems that are highly complex, adaptive and not rigorously rule-bound, the social sciences are among the most difficult of disciplines, both methodologically and intellectually. They suffer because their findings do sometimes seem obvious. Yet, equally, the common-sense answer can prove to be false when subjected to scrutiny. There are countless examples of this, from economics to traffic planning. This is one reason that the social sciences probably unnerve some politicians, some of whom are used to making decisions based not on evidence but on intuition, wishful thinking and with an eye on the polls.

...As Washington Post columnist Charles Lane wrote in a recent article that called for the NSF not to fund any social science: “The 'larger' the social or political issue, the more difficult it is to illuminate definitively through the methods of 'hard science'.”

In part, this just restates the fact that political science is difficult. To conclude that hard problems are better solved by not studying them is ludicrous. Should we slash the physics budget if the problems of dark-matter and dark-energy are not solved? Lane's statement falls for the very myth it wants to attack: that political science is ruled, like physics, by precise, unique, universal rules.

And here's some of what Mr. Drum added to it:

The public commonly thinks of disciplines like physics and chemistry as hard because they rely so heavily on difficult mathematics. In fact, that's exactly what makes them easy. It's what Eugene Wigner famously called the "unreasonable effectiveness" of math in the natural sciences: the fact that, for reasons we don't understand, the natural world really does seem to operate according to strict mathematical laws. Those laws may be hard to figure out, but they aren't impossible. ...

Hari Seldon notwithstanding, the social sciences have no such luck. Human communities don't obey simple mathematical laws, though they sometimes come tantalizingly close in certain narrow ways — close enough, anyway, to provide the intermittent reinforcement necessary to keep social scientists thinking that the real answer is just around the next corner. And once in a while it is. But most of the time it's not. It's decades of hard work away. Because, unlike, physics, the social sciences are hard.

Bonus points for the Foundation mention!

(I don't have much to add; I made a similar point in this post, comparing the complexity of marcoeconomic forecasting models to meteorological weather-forecasting models.)

Decision-making is not math: A lesson in the subjectivity of value

Mark D. White

Last month, The Economist published an article (based on research published in Journal of Marketing) on consumers' irrationality when compared discounts and added content:

Consumers often struggle to realise, for example, that a 50% increase in quantity is the same as a 33% discount in price. They overwhelmingly assume the former is better value. In an experiment, the researchers sold 73% more hand lotion when it was offered in a bonus pack than when it carried an equivalent discount (even after all other effects, such as a desire to stockpile, were controlled for).

In a recent issue, the magazine printed a letter by Rory Sutherland of Ogilvy & Mather UK, succinctly and humorously pointing out the problem with attributing irrationality to such consumers:

You mentioned research which revealed that shoppers often prefer “50% extra free” to a notionally more generous 30% reduction in price, and you cited this as evidence of irrationality or poor mathematical ability on the part of consumers. I think you may be wrong and consumers may be right.

There is, as the advertising sage Jeremy Bullmore observed, a significant difference between a bonus and a bribe. A price tells you much more about a product than merely what it costs. A price cut may be sensibly perceived as a mark of mild desperation on the part of the seller and it is not unreasonable to infer from a price cut that a product is an inferior good. Charging the full price but adding something extra does not convey the same desperation. In any case this whole debate is silly.

If people value 50% extra free more highly than 33% off, then that is an end of the matter. Since all value is subjective, what you are doing by offering the former is simply creating more perceived value at a lower cost. Whether or not the resulting behaviour conforms to some autistic neoclassical idea of rationality is irrelevant.

If the sole purpose of life was to be rational, we would have banned golf years ago.

Mr. Sutherland said it better than I ever could--and I've tried, in many places and many contexts, including previous posts (such as here), book chapters, and my forthcoming book, The Manipulation of Choice: Ethics and Libertarian Paternalism. Economists--of both mainstream and behavioral varieties--all too often see irrationalities where none exist because they insist on interpreting choice through the lens of their narrow understand of decision-makers and the overly simplistic choices they assume on consumers' parts.

The factors that consumers take into consideration when make choices are much more complicated than economists recognize--as Mr. Sutherland points out. And while behavioral economists are making headway in identifying some of these factors, they still don't account for qualitative ones like principles and ideals. Nor do they consider the complex and subjective interests of consumers (and all decision-makers), choosing instead to assume simple unitary goals like wealth-maximization. Until they take these common influences on choice into account, they will see irrationalities wherever they look--which reflects more on the shortcoming of their models than on the decision-makers themselves.