Contrasting views of economics
The week after the Nobel prize, two contrasting visions of economics:
1. Ramon Marimon writes that the award is a celebration of the “scientific method” in economic policy:
Part of the scientific method is to recognise not only the central problems and develop theoretical models providing analytical rigour to ideas and intuitions, but also to develop the methods and instruments that allow us to contrast these models with the data ‒ in this case, with the macroeconomic time series to analyse, for example, the effect of different fiscal and monetary policies. Sargent and Sims distinguished themselves by developing new econometric methods for the analysis of rational expectations dynamic models, which are nowadays an integral part of the toolkit of the empirical macroeconomists, whether in academia, in central banks, or elsewhere.
This is a highly optimistic reading of rational expectations, which, it shouldn’t be forgotten, underpinned some of the worst bits of theory that contributed to the crisis, including the efficient markets hypothesis. A version of the EMH amongst other things said that stock market prices are usually correct because they reflect all available information. It was central to the pricing of derivatives — the financial time-bombs that exploded global markets. And EMH was proved wrong when markets crashed. It turned out — surprise, surprise — that prices were completely incorrect and hadn’t reflected the information available. The “toolkit of the empirical macroeconomists, whether in academia, in central banks, or elsewhere” has taken such a beating that not many people trust economists any more.
Economists don’t, in fact, follow the kind of Popperian scientific method put forward in Marimon’s piece (and in fact the physicists whom economists so profess to admire don’t follow it either). The idea that humans are singularly rational, self-interested utility maximisers is an ideology, not a widely-accepted mode of behaviour. It hasn’t withstood the test of reality, as Marimon suggests. Keynes scotched this idea about half a century earlier. Behavioural economists as well as psychologists have cast strong doubts on the idea that there’s some central notion of rationality. Yet a large number of economists continue to cling to the notion, regardless.
2. A more realistic view is presented in a review of two new books by Yanis Varoufakis and colleagues in Modern Political Economics: Making Sense of the Post-2008 World; and The Global Minotaur: America, The True Origins of the Financial Crisis and the Future of the World Economy.
As capitalism evolves, its tendencies become clearer; at each stage, economists come to think they’ve finally figured it all out, then History proves them wrong again, from Quesnay and the Physiocrats to Smith and Ricardo, forward to Marx and beyond.
There’s no reason to think we’ve got things right this time — and indeed the crisis suggests otherwise. Rational expectations belongs to:
… a strain of economic thought purporting to have established with scientific rigor that the economy was simply a market, a natural (read “self-regulating”) system.
It was just another ideology with a team of supporters in prominent academic positions. We now know — and a lot of people knew beforehand — that the self-regulating system didn’t regulate itself very well, and that the “science” was flawed.
And Varoufakis is quoted as saying that:
…success is as divorced from the theory’s truth status as the theory is from real economies.
Most scientists will tell you that falsification, based on Popper’s original idea, is a dream. Science as practised in the real world is usually about trying to prove your pet theory; not disprove it. Empirical testing, especially in economics, doesn’t really involve objective self-critique — what’s left out of scientific enquiry is more interesting than what’s included. Economics is probably more a process of rhetoric, as Dierdre McCloskey pointed out, subject to paradigm shifts rather than the progression of trial-and-error.
So no, economics isn’t a science of society, drawing ever closer to the truth. It’s an ideology, which can contribute to social problems as much as it helps solve them. We’ve no more sorted out the world’s economic problems than did Quesnay, Smith, Ricardo or Marx. And indeed no single ideology is likely to do so, because each epoch brings with it new challenges. Only by genuinely opening up the field to radical new ideas will economists have any chance of tackling the challenges of the future.