Economics' greatest hits? ... or... Where's the science in economics?

June 23, 2009 12:54 PM

As a former scientist, help me gain some faith in economics. What were the great successes of economics as a tool for making better decisions in the last 100 years?

The Queen of England said it best for me : Why did none of the big shot economists see this crisis coming?

Having been scientifically trained, I have always had this belief that economics is a mostly mathematical rationalisation of events after-the-fact with the same predictive capabilities as astrology and whose validity decreases as more people believe in it. Why am I wrong? what demonstrable uses has it had? Also interested in any books or papers discussing either side of this debate.

posted by zaebiz to science & nature (20 comments total)

I asked about this, previously, so I'll be following your thread with interest.
posted by grumblebee at 12:56 PM on June 23

(a) Big shot economists did see the crunch coming. Just not all of them, and people didn't listen to the ones who did. Look at Nouriel Roubini for instance. Or look at practitioners with an macro bent, like Jeremy Grantham's "Anti-Risk" letter from GMO.

(b) Economics is called the dismal science for a reason. I don't think you are wrong. As far as I know, the only useful result (with predictive capability, etc.) in economics has been the Black-Scholes model.
posted by jeb at 1:07 PM on June 23

What were the great successes of economics as a tool for making better decisions in the last 100 years?

A hundred years ago, many people thought communism was a great idea.

But besides that, one can point to the Keynesian revolution.
posted by Cool Papa Bell at 1:16 PM on June 23

Some did. Some certainly saw parts of the picture.

Economics has given policy makers and regulators a broad range of subtle tools and ways of understanding what is going on, what happened and what's likely to happen as the result of decisions made. The fact that politicians and the beltway talking heads ignored them doesn't make them wrong. If you look past the fluff of the rants and narrow-minded talking heads, you'll see decisions very much driven by the understandings that economics has generated.

The decision to spend now in fiscally expansionary ways is very much driven by the lessons of the depression, what happened then and how policy decisions made a bad situation worse, and ultimately how policy decisions made things better.
posted by idb at 1:19 PM on June 23 [1 favorite has favorites]

My guess is, the softer the science, the less predictive its results. "Some" saw it? Please. If "some" could not persuade nearly all, then how are we to distinguish their vision from chance or faith? Broken clocks and all that.

(And some claim that Black-Scholes is less than it was cracked up to be.)

Then again, I suppose we could be where medicine was a thousand years ago. Some things worked, doctors took credit, some didn't, doctors pointed at Evil Spirits.

Either way, doctors got paid.
posted by IndigoJones at 2:06 PM on June 23

If you agree with Robert McNamara, game theory helped keep the US and USSR from nuking each other during the Cold War.
posted by Blazecock Pileon at 2:21 PM on June 23 [2 favorites has favorites]

This is a tough question How would we see Economists had done a good job? As a scientist you should know we need a counterfactual world without economics to see if they have done a good job. Macro economics is difficult, because your sample size is usually so small. But a few thoughts as an Economist.

1. I'm not a macroeconomist, that is I don't research what is going to happen in the US or World Economy. In fact most economists are not macro economist who specialize in predicting what will happen next in the economy. There are lots of other things we do for instance I look at how different factors that impact children's school attendance in Latin America.

2. The Federal Reserve System is older than 100 years, but while there is a lot of debate, they seem to be doing a pretty good job at fighting inflation and maintaining a steady economy. If you research you will be able to find people who say we should abolish the system. But if you look at examples like the Volkers management in the late 70s, Greenspan's Fed's management in the late 80s and 90s. Research wise the Taylor Rule seems to be a good theory that has worked. Sure you can find articles saying these are failures and wrong but there is a general positive consensus.

3. Economists have had good succesuss in promoting free trade. While this developed from a theory from the 1800s (Ricardo), I would point to it as one of economics good outcome.
posted by akabobo at 2:32 PM on June 23 [1 favorite has favorites]

Frankly, this is a really insulting question, especially the insinuation that derision of economics (and presumably other social sciences even more so) is a natural consequence of being a REAL scientist. If physicists are so damn smart, how come they didn't predict the October 2006 snowstorm in Buffalo by 2003 at the latest?

Yes, of course economics is going to have less predictive power than physics, because economics (and other social sciences) aren't dealing with just aggregations of dumb matter and simple energy... hell, they aren't just dealing with human mentalities. They're dealing with what happens when a zillion different human mentalities all interact at the same time. Of course the predictions it offers are going to be rough and filled with noise.

Likewise, academic economists (AFAIK) generally don't study questions like "Given the current set of regulations of the financial market in all their gory detail, the areas where the markets are unregulated, and a host of other factors, what is the probability of a huge economic downturn in the near future for a given vector of price-trajectories for major commodities such as oil, and oh yeah those trajectories are also partly endogenous?"

Successes, or at least partial successes with ongoing problems of convincing people, of economics include:

*Cap and trade pollution programs
*Any other program built around internalization of positive or negative externalities
*Anything based on cost-benefit analysis and the underlying attempts at estimating those factors, such as the removal of lead from gasoline
*Trade liberalization
*Allocation of landing rights
*Countercyclical spending policy

(just off the top of my head)
posted by ROU_Xenophobe at 2:53 PM on June 23 [14 favorites has favorites]

Why did none of the big shot economists see this crisis coming?

Well, on the micro level, economics is used sucessfully every day by companies to determine pricing, supply, etc. for profit maximization. On the macro level, things are understandably a bit more complex. It's like asking, "What good is the science of medicine since nobody warned us about swine flu until people started getting sick?" Remember that economics is not necessarily supposed to predict the future, but to help make decisions in the face of limited resources.

What were the great successes of economics as a tool for making better decisions in the last 100 years?

I am not a Keynesian, but Keynes certainly deserves to be on any list of economic success stories for at least two reasons:

1. Keynes was all over FDR about letting go of the purse strings during the Depression to end it - FDR actually tried to maintain a balanced budget up to 1938. Keynes had numerous conversations with FDR and believed that had he been much more aggressive with deficit spending, the Depression would have ended much sooner. Even though FDR was confused by Keynes’s recommendations, had Keynes not told him to stop worrying about deficit spending, Roosevelt might have been less committed to bringing about Lend-Lease (to which there was substantial domestic opposition), which might have led to the defeat of Great Britain before the U.S. even entered the war. The "tool" in this case was deficit spending.

2. Keynes' critique of the Treaty of Versailles at the end of WWI accurately forsaw the economic wreakage stemming from the treaty, which would contribute to WWII. That gave the Allies pause after the second war, and contributed to the formation of a prosperous Germany and Japan.

Other economists and their success stories? Search for Margaret Thatcher and Frederick Hayek, and Paul Volker and stagflation, Milton Friedman and monetarism (as you probably know, Greenspan and Bernake are often criticised for not tightening the money supply earlier which supposedly would have avoided the bubble and thus the current recession. So monetarism could have been a tool for avoiding the recession, according to the critics.).

On preview - I agree with all three of akobo's points and, uh, my point on medicine is kinda similar to IndigoJone's.
posted by txvtchick at 3:04 PM on June 23 [1 favorite has favorites]

What were the great successes of economics as a tool for making better decisions in the last 100 years?

The Marshall Plan was a pretty good success:

The years 1948 to 1952 saw the fastest period of growth in European history. Industrial production increased by 35%. Agricultural production substantially surpassed pre-war levels.[67] The poverty and starvation of the immediate postwar years disappeared, and Western Europe embarked upon an unprecedented two decades of growth that saw standards of living increase dramatically

posted by Civil_Disobedient at 3:17 PM on June 23 [2 favorites has favorites]

I'd say each of the two parts of economics has given us one obvious giant contribution to human well-being:

• Macro has given us the understanding that monetary policy is deeply intertwined with business cycles and gotten us to the point where it seems that central banks can reliably improve the stability and prosperity of an economy by tweaking factors that influence the money supply based on some very simple principles. Until this current crisis, many people seriously considered the idea that we had pretty much "solved" severe recessions altogether.
• Micro has given us an absolutely overwhelming case for free trade, which is the basis of the huge worldwide economic progress of the last hundred years or so. The case was pretty much articulated perfectly by Adam Smith in 1776, but in the last century we've seen the biggest benefits, and the theoretical foundations have been deepened and elaborated greatly.

There are many others, which others here are doing a good job of drawing out, but I think these two need to be emphasized.
posted by abcde at 3:31 PM on June 23

I'm not an economist nor a particular fan of economics, but let me defend economics anyway. First, I don't think pointing to "successes" or accurate predictions necessarily vindicates a field since you basically have a numerator (successful uses/predictions) without the denominator (number of predictions/ideas). There's no way to determine based on examples if the predictions of the field as a whole are better than chance.

However, I'd like to challenge the premise of your question which basically argues that it's not science if it can't predict. Not all science is based on a prediction model, You may be interested in this article arguing that there are other models from the "hard sciences" that are more applicable to the social sciences than prediction. From the abstract:

"Darwin’swork on evolution provides a far more applicable model for linking theory and research since he dealt with obstacles far more similar to our own. This includes drawing rigorous conclusions based on observational data rather than true experiments; an ability to absorb enormous amounts of diverse data into a relatively simple system that did not include a large number of what we think of as independent variables; the absence of prediction as a standard for evaluating the adequacy of a theory; and the ability to use a theory that is incomplete in both the evidence that supports it and in its development."
posted by If only I had a penguin... at 3:47 PM on June 23 [2 favorites has favorites]

Economics is also called "the dismal science", though perhaps for reasons other than it's science or lack thereof.

Scientific experimentation of economics can be done, but mostly in "microeconomic" situations, where you can study the behavior of individuals in the same society. When you start looking at the state of a nation, rather than individual actors, it becomes impossible to run an experiment with any rigor--do you know of any twin nations available for twin studies?

But consider this: Credit Default Swaps were invented (not discovered) in 1997, and played a central role in the current disaster. Because these were over the counter, it's hard scientifically investigate:

Bloomberg CDS quotes are a freaking mess... For itraxx quotes, there is also no guarantee they are correct. This is because the given quotes come from many different sources and are sort of averaged. So what you download for, say, 7yr Hivol may well be a few bps away from the market if some stoupid bank keeps a stale quote for a couple of days. ...On top of that, nobody....NOBODY...at bloomberg could tell me exactly what is done to the quotes.

So yea, it's pretty damn hard to see what's going on when nobody's telling you and everything is done in private. While we're at it, I should point out that economists don't restrict themselves to market analysis, and market analysts aren't restricted to economists. There were people who saw the real estate run-up and politically connected TV personality economists who denied it was a problem even as it was happening.

But you're asking for important science and demonstrable results. A good start would be the Memorial Prize in Economics in honor of Nobel. Not quite the Nobel prize, but established to duplicate it. Coase would be a good place to start, with two top accomplishments, one about why and when we have
employees instead of contractors, and one on how to efficiently decide who pays externalities such as pollution.

But given the context of your question, how about the copious amounts of science in the lab that suggest that investment bubbles are part of human nature, perhaps someone can dig up a quality citation on the subject?
posted by pwnguin at 3:50 PM on June 23 [1 favorite has favorites]

(And some claim that Black-Scholes is less than it was cracked up to be.)

The Forbes article misses the point. It's true that nobody uses Black-Scholes as it was originally presented because it makes certain unrealistic assumptions (e.g. constant vol, normally distributed returns) and you can observe the prices of vanilla options in the market anyway.

The point is that you can use a Black-Scholes-like approach to price financial instruments that do not have prices observable in the market (e.g. exotic options or over-the-counter deals). People make all sorts of modifications to the original Black-Scholes model, such as allowing for time-varying volatility, or adding random discrete jumps to changes in price, but this is still under the basic framework used by Black and Scholes (and Merton).

So yes, if one wants to argue semantics, nobody actually uses the original Black Scholes model, and they may not have been the first to come up with such a model. But the framework which we call "Black-Scholes" is widely used today to price derivatives, and can certainly be regarded as one of (financial) economics' greatest hits.
posted by pravit at 3:51 PM on June 23

Lately economist have begun using mmorpg as laboratories for macro economy experiments. It is a testament to success of economics as a science that all companies running mmorpgs employs a team of economy Ph.D.'s in order to design and tweak their artificial economies.
posted by gmarceau at 5:11 PM on June 23 [3 favorites has favorites]

Part of the premise of this question is questionable.

People did see the problem coming. The Economist, the journal of center right othodoxy had an issue in 2005 with the question of whether there was going a big crash caused by a decline in housing prices. It was posted to MeFi. When an asset shoots up over historic norms there a lots of mainstream economists who start saying that things will turn south.

Similarly the dot com crash was also brought up in The Economist about 2-3 years before it happened.

In late 2002 I was talking to a hedge fund employee who said to me that he wished he could short housing because it was probably overpriced compared to historic prices.

Economics is a Social Science and uses quantifiable, falsifiable statements and models. Perhaps more than other social sciences tend to.

It doesn't make good big predictions about where the economy is going. But - it does give lots of useful quantifiable results for some questions as pointed out by Jeb and Blazecock Pileon.

There are economic descriptions models of bubbles and crashes. Check out Hyman Minsky and read Manias, Panics and Crashes to see how Minsky's ideas look in when looking at history.
posted by sien at 8:13 PM on June 23 [1 favorite has favorites]

People have written far too many words on this topic.

I can boil it down to this: As long as economies are subject to the whims of human beings, the predictive nature of economics as a "science" are dubious at best. The recent rise of behavioral economics does give me some hope.
posted by PsuDab93 at 7:21 AM on June 24

Economics has been good at pointing out how handling scarcity can be counter-intuitive; see Amartya Sen and the Grameen bank (which is just a rehashed answer from me from here). The idea it is all about infrastructure and rapid communication and transportation as opposed to a limit in strict X amounts of whatever good is needed is a pretty important one, and partly stems from the free trade proposition, yes, all the way back to good ol' Ricardo and all that.

That said, what you're talking about, the problematic nature of the dismal science, is old hat. Thorstein Veblen's "Why Economics is not an Evolutionary Science" comes to mind. And I wish for the life of me I could remember the specifics of it, but my last year in college finishing up my econ degree I did a capstone project that involved a paper written in the 1920s using economic methodology to "prove" statistically that economic methodology was, ehrm, useless. Classic.

All of that said, what is appealing about econ is the way it strives to use quantitative methods to challenge and evaluate kneejerk assumptions about just about everything we know socially. That is still a pretty awesome premise for establishing a perspective of the world, at least to me...
posted by ifjuly at 1:36 PM on June 24

People have written far too many words on this topic.

I can boil it down to this: As long as economies are subject to the whims of human beings, the predictive nature of economics as a "science" are dubious at best. The recent rise of behavioral economics does give me some hope.

This, in turn, is somewhat ridiculous. The simple fact that central banks frequently produce forecasts which accurately predict economic growth shows that economics has nontrivial predictive power.

It really boils down to economics consisting of two tiers. Microeconomics is theoretically sound and continues to grow with the addition of behavioral considerations. Macroeconomics has been a question mark for decades (centuries?). However, I'd argue that economics is currently trying to understand how an economy (and all its complex, human-based systems) operates--similar to how physicists are trying to understand the formation of the universe.
posted by achompas at 3:21 PM on June 24

What kind of decisions do you want help making? Macro policy is a very hard problem.

One could argue that economics as a discipline has been very successful at solving policy questions but that other groups influence and pervert the implementation of policy.

For instance, John Taylor has argued that poor monetary policy caused the crisis; the Fed deviated from its [approximate Taylor rule] policy behavior starting around 2001 and kept interest rates far too low. One interpretation is that political pressure or unusual fear of economic contraction led to expansionary monetary policy that inflated the business cycle into a boom and then a bust. The Taylor rule is good policy but we got bad policy.

Okay, but there's certainly another possible realization of history where the global economic reaction to 9/11 was more severe, and maybe some bad stuff happened (unpredictable events, weather events or conflicts or epidemics!), and the Fed's low interest rates turn out great, the housing market cools off, and everyone's happy. The global economy is everything that happens in the world. Maybe the Fed had sincere beliefs that things were going to get real rough if they contracted the money supply. Only a portion of those beliefs are influenced by economic knowledge, and nothing is knowable in advance.

Okay, there's my rambling on the most visible macroeconomic policy. A defender of economics could say that good policy gave us The Great Moderation and years of low inflation and high growth and that the recent crisis is the result of bad luck and/or politics perverting policy. Really, macro policy is just a fundamentally hard problem, and it's always improving. It almost definitely deserves "greatest hit" status but if you want to believe it's total shit you can. We only get to observe one realization of history. [Yes, using MMORPGs to do macro experiments is awesome. No, there's no way you could convince someone those results apply to the actual world economy if they didn't want to believe it.]

I could go on for hours about microeconomic success stories, but reading about the Nobel prizes would probably be more helpful to you [and I'm confident my insomnia will go away soon].
posted by L0 at 5:36 AM on June 25 [1 favorite has favorites]