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How Did Economists Get it So Wrong?
That's the title of Paul Krugman's long essay on the recession's impact on academic economics in the New York Times Magazine. This is self-recommending.
The thrust of the argument is that over the years economics (in particular the neoclassical Chicago school) lost sight of John Maynard Keynes's insights into the role of unpredictable behavior in financial crises. The "freshwater" economists took the upper hand in academia because their models, while useless for describing recessions, were beautiful and simple in their mathematics. The current recession, however, has jolted them as well as the complacent New Keynesians at "saltwater" schools (i.e. the Ivies, MIT, and Berkeley) out of their complacency and should lead to a renewed appreciation for Keynes.
The essay covers a lot of ground and there's a lot to say about it. For one thing, I think that the point about the most technical, mathematical models beating out less buttoned-down but more descriptive models says something about the state of higher education.
I learned economics at Notre Dame, from Marxist professors (Notre Dame had until very recently one of the most "heterodox" economics faculties in the U.S.). Even these far-left economists taught us the neoclassical models that Krugman implicates, such as the efficient markets hypothesis. Why? Because they could take it out of a textbook, check our math to see if we did it right, pass us, and have the job done with. Teaching us otherwise would have taken a concerted effort. They weren't interested in doing so because their brand of economics was unusual enough that they would be faulted for poor teaching if they convinced us of it. We weren't interested in learning it, either, because most undergraduate economics majors just want a job in investment banking. So the compromise was to teach the perfectly acceptable models that didn't really increase anyone's understanding of the world. I strongly suspect that similar influences were at work at the graduate level as well.
This is failure of institutional academia, not of economics, really. True, economics should not have become so mathematical in the first place. But the truth is that something similar could have happened with any social science. Furthermore, it's not quite right to say that the excessive mathematics were the work only of Chicago economists. In fact there's a whole history behind that that involves, among others, the Cowles Foundation at Yale, specifically tasked mid-century with formalizing mathematical economics, and Paul Samuelson's influence at MIT -- both very much "saltwater" schools.
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L. Ross| 9.3.09 @ 2:07PM
This looks like a topic for Bob.
Toot toot, tweet tweet.
Tim| 9.3.09 @ 2:24PM
When did they ever get it right?
Robert Stacy McCain| 9.3.09 @ 2:28PM
Hayek and Mises, Joe -- Hayek and Mises.
Joseph Lawler| 9.3.09 @ 2:44PM
RSM: preaching to the choir. At least as far as Hayek is concerned, I've never actually read Mises.
Dixie Pixie| 9.3.09 @ 2:59PM
Mathematics is a language that is useful for modeling parts of reality. It is most useful where it is closely congruent to observable reality like Physics. In this case the power of Mathematics lies in its ability to be invariant for anyone. Simply put the Laws of Physics and Mathematics are the same for anyone anywhere anytime.
Economics, however has a major irrational and nonlinear component called the human race. As a result mathematics is less useful for modeling economic behavior. The major problem is humans react to changes in economic conditions resulting in mathematical feedback loops which leads to indeterminate mathematical conditions. In short Economic Laws have only mathematical loose and local congruential relationships to reality. Economic Laws are not the same for anyone anywhere anytime.
Also Politicians and Business Executives will pay for economic analysis pleasing to them and will not pay for economic analysis which would put the preferred policies as wrong. In short Economics are bent to preferred conclusions rendering any conclusions mathematically meaningless.
Alan Brooks| 9.3.09 @ 3:10PM
resistance to Obama is helping to facilitate economic activity.
1993-->> 2009
Jeff| 9.3.09 @ 3:32PM
Dixie Pixie wrote, "Economic Laws are not the same for anyone anywhere anytime."
That is false. See Mises' "Human Action," and Rothbard's "Man, Economy, and State."
- Human action is purposeful. (Although the purposes may not be good or rational.)
- Time is scarce. (Thus, the need to economize.)
- Value is strictly an ordinal concept not a cardinal one. (Implying immediately that prices do not indicate value but something else. Hint: scarcity.)
- The future is uncertain.
- All production of goods takes place in time.
These economic facts are true everywhere at all times. And from them the entire edifice of economics can be deduced without resort to descriptive mathematics.
Business hire economists for basically one reason: one can make an accounting profit but take an economic loss. People like to know that stuff, but of course they never tell the shareholders.
jr| 9.3.09 @ 5:22PM
I had an Econ prof 50+ years ago at a city college who described the problem with the Fed Reserve and its power. There was no math or science to that. Likewise there is no math, physics, or economics that can fit a curve to mortgages, goobermint interference in private business, and playing and betting with the market. Disaster! Some pundits are saying that the recession is nearly over. For those who are in the know, tell us when companies start paying higher dividends, that will tell me that people are back to work and American manufacturers are selling.
BOB| 9.3.09 @ 6:17PM
TOOOOOT! I HAVE BEEN SUMMOND! TOOOOOT - DO NOT STARE AT THE FUNNLE ATOP MY HEAD THAT EMITS STEAM AND TOOTS! L ROSS, YOU HAVE DARED AWAKEN ME, “BOB THE EDUCATED”! AS YOU CAN SEE, I HAVE HAD MY FUNNEL FIXED! TOOOOOOOOT – I AM CALMED MYSELF OF YOUR FOOLISHNESS FROM OTHER POSTS! TOOT!
WHY HAVE YOU BOTHERED, “BOB THE EDUCATED, KNOWER OF ALL KNOWLEDGE, SEER OF FUTURE EVENTS, CEO OF 176 FORTUNE 176 COMPANIES”? TOOT! FOR THIS CHILDISH ARGUMENT OF CLASSICAL ECONOMISTS VS KEYNSIANS? THIS IS UNWORTHY OF “BOB THE MONSTER BRAIN” YOU UNEDUCATED DOCTORS, PILOTS AND MBS FROM STATE SCHOOLS ARE SILLY! TOOT! EVERYONE KNOWS OBAMA “THE SMARTEST” IS DOING THE RIGHT THING BY FOLLOWING KEYNES! THE MORE STIMULOUS, THE BETTER! TOOT! CASH FOR CLUNKERS WAS A SCEAMING SUCCESS, YOU PIFFLE PEDDLING POLTROONS! NOW BEGONE WITH YOU AND YOUR SILLINESS – I AM THINKING GREAT THOUGHTS, WAY ABOVE YOUR MEAGER MINDS! LIKE HOW TAXES DO NOT AFFECT WHAT BUSINESSES DO, HIRE, OR WHERE THEY LOCATE! TOOOOOWEEEEETOOOOOOOT!
Bob| 9.3.09 @ 6:41PM
Joseph, the mathematical issue is one of identifying variables and assigning them the proper beta. There are so many variables, that no model contains all of them. In addition, while some variables are mutually exclusive, the vast majority of variables are dependent.
For these same reasons, it is possible to argue for either Keynesian or supply side theories since these are verified with selected variables.
This is why economists are such poor forecasters -- they use selected -- not all -- data. In practice, neither Keynesian or supply side theories work much of the time. The electorate, both right and left, buy into over simplistic theories that are consistent with their ideologies.
The "human" factor can, indeed, be measured. However, the timing of the reversal inflection point is almost impossible to predict given the common exaggeration in human behavior. This is much like predicting when a balloon will pop as we fill it with air. If we bet on this timing, the bigger the balloon gets, the greater the bet since humans make their own decision on how large that balloon can get. This is what happens with all bubbles.
I saw the housing bubble coming, but I thought that "balloon" would pop about a year and a half before it did. As far as I know, there was no measurement of housing bubbles in any of the mathematical models I've seen.
My problem with the teaching of economics is that it depends too much on particular theories and not enough on creative thinking about variables. None of the economics courses I took many years ago did any creative thinking on potential variables -- they primarily used standard measures.
I've shown here many times, on a macro basis, that tax cuts are not stimulative. No economist has disproved that using normalized data and multiple incident analysis. In addition, there is evidence that government stimulus is only slightly stimulative. Keynes was right regarding the benefit of spending, but he never answered the question whether the rate of return on that spending was positive. Trying to mathematically figure out whether spending is stimulative is much more difficult than determining the same with tax cuts. I've come to the conclusion that government spending and the level of taxes has only a peripheral impact on the total economy. There seems to be a much higher correlation between monetary actions and the economy.
Again, the problem with educational institutions is that they rely too much on theory, and not enough on practice, in my opinion.
Incognitii| 9.3.09 @ 6:51PM
It's disingenuous and intellectually sloppy for Krugman to castigate the University of Chicago for promoting neoclassical economics. This may be the school's soup de jour, but the UofC is an institution where all good ideas can excel.
Which macroeconomic school does Krugman support at the end of his article? Behavorial economics! Where was this field developed? Ever heard of a man named Becker? How about Thaler? This is also framework largely developed at UChicago.
Krugman: If you're giving the UofC grief for promoting neoclassical economics, please give it credit for also developing the alternative cause that you now champion.
Dixie Pixie| 9.3.09 @ 6:57PM
To: Jeff
Nice argument from authority. Unfortunately your counter-argument does not match observable reality.
For example, The “Miracle of the Cattle Futures” provide a case where economic laws was not invariant for anyone anytime anywhere.
To recap Hilliary Clinton claimed to have invested $1,000.00 dollars in cattle futures and made $100,000.00 dollars in return. A 100 to 1 return on investment. A number of news reporters tried to duplicate the feat to prove Hilliary could do it. If the economics truly were invariant then everyone should make the same amount of money. No one duplicated Hilliary's feat thus proving the economics were bent in Hilliary's favor.
The problem with argument's from authority is the final result depends on which authority you cite.
For example, Obama claims the Stimulus Bill is working, Sean Hannity claims the opposite. Pick your authority, get your preferred result.
My point is mathematically modeling human economic behavior is difficult. The difficultly is magnified by the efforts of the Legal and Political Class to rig the economic system in their favor. Consider Senator Kennedy as an example.
BOB| 9.3.09 @ 7:17PM
TOOOTY TOOT-TOOT “BOB, THE KNOWER OF ALL” HAS SPOKEN!” TOOT! AND AS YOU SEE, I CAN WRITE VOLUMES OF LONG WINDED FLAPDOODLE, USING JARGON SUCH AS “BETA” AND DRONING ON ABOUT HOW PREDICTING WHEN “BUBBLES” WILL BURST IS A FOOLS GAME! TOOOT! I DO THIS TO IMPRESS YOU FUNCTIONAL ILLITERATE DOCTORS, PILOTS AND STATE UNIVERSITY MBAS! I KNOW MY WHOLE ARGUMENT CAN BE SUMMED UP THUSLY (THAT IS HOW WE EDUCATED PEOPLE, LIKE OBAMA AND JOHN KERRY, SPEAK, YOU RUBES!): ECONOMISTS ARE TO THE ECONOMY AS WEATHER MEN ARE TO THE WEATHER!
BUT NO! TOOOOOT! I MUST PONTIFICATE! TOOOOOOOOOOT! YOU HAVE ANGERED “BOB THE NAGNIFICENT”! GET IT, STUPID BUMPKINS! “NAGNIFICENT”! I NAG YOU ABOUT YOUR STUPIDNESS! TOOOT! HA HA HA! I KILL ME! I CLUCK MY TONGUE AT YOU UNEDUCATED, NON-IVY LEAGUE DIM-WITS! TOOOOOOOT!
Dixie Pixie| 9.3.09 @ 7:28PM
Okay, Who spiked BOB's water supply with raspberry alcohol???
BOB| 9.3.09 @ 7:35PM
TOOOOOT! *HIC* TOOOOOOT!
Xanthippas| 9.4.09 @ 10:01AM
This is failure of institutional academia, not of economics, really. True, economics should not have become so mathematical in the first place. But the truth is that something similar could have happened with any social science.
Eh, I don't think so. There was a lot more money in those theories then in, say, sociology theories about how prison's should be run.
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Daisy| 9.4.09 @ 4:15PM
LOL! Sounds more like "BOOB" dropped a little (okay, a lot!) Acid.
Funny as hell. Thanks for the laughs.
psikeyhackr| 9.6.09 @ 6:21PM
It's 40 years after the Moon landing and Krugman got his PhD in 1977. What has he said about the planned obsolescence of automobiles? How much have Americans lost on the depreciation of crapmobiles every year since 1969?
Our so called economic system depends on economists that can't do algebra. Double-entry accounting is 700 years old. How hard can it be with today's computers? When have our economists suggested that it be mandatory in the schools?
NO! We need to keep the consumers $tupid. That would screw up our game theory.
http://www.spectacle.org/1199/wargame.html
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