Leech the economy

Anatole Kaletsky's evisceration of "old economics" in the London Times may be consistent with the general backlash during the current recession, but it's half-baked.

Today’s academic approach prevented economists from thinking about a world that is, by its very nature, unpredictable and inconsistent... others may revive the literary and anecdotal traditions of the great economists of the past... Smith and Hayek produced no real mathematical models. Their eloquent writing lacked the “analytical rigour” demanded by modern economics. And none of them ever produced an econometric forecast.

To wish simultaneously for a return to an "anecdotal tradition" and for theories to be "tested against reality" is perverse. The economy is indeed a complex system, and to draw correct conclusions on the relationships in a complex system requires more than anecdote. As epidemiology is to medicine, so econometrics is to economics; a
patient's recovery after leeching does not prove leeching effective, and folk inference in economics would be just as counterproductive, in its own way. The "analytical rigour" so disdained by Mr. Kaletsky represents the struggle to understand and draw inference from the very real complexity that to rely on anecdote risks ignoring.

The first idea, known as “rational expectations”, maintained that capitalist economies with competitive labour markets do not need stabilising by governments.

The second idea — “efficient markets” — asserted that competitive finance always allocates resources in the most efficient way, reflecting all the best available information and forecasts about the future.

The specific "theories" attacked by Mr. Kaletsky are also grossly misrepresented. Hell, the concept of a theory is being misrepresented. An economic theory is an if-then statement, and this is not a matter of mathematics, which is after all just a language like any other. No theory, no matter how it is expressed, can ever do more than suggest the outcome that would pertain under a given set of conditions. No theory, then, can "[maintain] that capitalist economies... do not need stabilizing by governments", or "[assert] that competitive finance always allocates resources in the most efficient way". To attack the assumptions underlying these theories is good and rigorous; to either attack the value of their existence is to distort the purpose of academic inquiry. It is precisely because
theories are if-then that any single conclusion can be given an 'if' and be co-opted and championed by the politically powerful of the moment, but the "assertions" come always from the interpreter, not from the theorem.

Literary and cross-disciplinary approaches to economics can have great value in conveying economic ideas and in complementing other forms of research. What would be unacceptable, however, would be the abandonment of valuable tools to help us to understand the way things are. Perhaps attacking economists makes us feel better, but this is like blaming the shipbuilder, engineer or mathematician for a drunk captain's crash.

And finally, because that felt a bit too serious, I must mention these:

Today’s academic economics reverses this process: if models disagree with reality, it is reality that economists want to change.

Policymakers who turned to academic economists for guidance in last year’s crisis were told in effect: "The situation you are dealing with is impossible: our theories prove that it simply cannot exist."

This is garbage.

It's called "the ivory tower"

Here's a thoughtful antidote to "boo economists!" by Barry Eichengreen at The National Interest. Perhaps the most forceful point is this:

What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. In fact, these observations and others had been imaginatively elaborated by contributors to the literatures on agency theory, information economics and behavioral finance. Rather, the problem was a partial and blinkered reading of that literature. The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object. It is in this light that we must understand how it was that the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.

Eichengreen notes that business schools, for example, are part of the production line of financial labor and ideas and so have no inventive to rock the boat; however, he also directs a lot of fire at academic economists for being part of the stitch-up. I accept that the author surely knows better than me the "pecuniary and psychic" benefits to academics from the use of their work, but a counter-hypothesis would be ignorance rather than malice, a sin of omission, not commission. How many in economics departments know what's going on in industry - or even business schools? Is it enough to claim a quorum of the profession?

There's probably analog to the hard sciences here. Newspaper science (cf. Bad Science, for example) is to natural science research as financial industry models are to economics research, or something like that. Imagine a house full of economists (reality show idea?) - every so often one wanders out to hand some obscure technical document to someone from the outside world, and something inevitably gets lost in translation. 

Measurement again

From the New York Times:

During the boom years of the Bush presidency — remember them? — economic growth was an especially unreliable indicator of how most Americans were doing.

Our problem, again, is that semantically dead word 'economics'. 'Economic growth' is an especially fun one, not least because it actually refers to growth in GDP, which is something that's kind of confusing anyway. Look at this catalog of misery:

The numbers were impressive, but the gains were lopsided, benefiting executives and investors far more than hourly workers and salaried employees. Because the growth was fueled by reckless lending and borrowing, it created an illusion of wealth even as many Americans lost ground...

The government reported that the economy grew at a surprising 3.3 percent in the second quarter, while productivity (the measure of how much workers accomplish per hour) soared. Unfortunately, those bounces did not mean a rebound in the lives of most Americans.

Growth rose, but so did unemployment. Productivity surged, but wages fell. Fixing that disconnect is the central economic challenge for the next president.

Increased exports were responsible for last spring’s strong economic growth numbers. But selling more abroad has not led to more manufacturing jobs or working-class pay raises at home.

Oh my. One point is that the popular metrics - like 'growth' - clearly aren't capturing everything that's relevant, but we knew that. Another would be that it's therefore pretty odd that we continue to use the word economics when, lo, it's actually two degrees away from making sense: first, it usually means something like GDP or unemployment or productivity or something, and second, even that wouldn't actually tell a proper story. 

Yet a third point is that the title of the article is "Real Life Economy": seems like there's a bit of a trust issue developing with the metrics the media reports when they talk about 'the economy'. Economists look silly again, but was it their fault? And are we surprised?