There has been a lot of discussion of this recent article by Barry Eichengreen in The National Interest. In a nutshell, Eichengreen’s argument is we should not blame economic theory for the failure to anticipate and avoid the financial crisis. Theory had the tools—agency theory, asymmetric information, behavioral economics—to do the job. The problem was that some academic economists were seduced by extramural income opportunities to ignore these subfields, while the others followed along to avoid the costs of nonconformism. Fortunately, he concludes, economics is becoming more empirical, so embarrassing episodes like this will be less common in the future.
Some parts of this are unarguable. There were important theoretical developments during the past 20 years that can be drawn on to understand what went wrong. To a considerable extent, the economics profession has been suborned; it has bent itself, heliotropically, to the sources of its enrichment. Nevertheless, I would take issue with Eichengreen on two main points.
First, economic theory, taken as a whole, is culpable. The core problem is that each theoretical departure, whether it is a knotty agency problem or a behavioral kink, is inserted into an otherwise pristine general equilibrium framework. The only way you can get an article published in a mainstream economics journal (and therefore reproduce the conditions of your existence as an academic economist) is to present your departure piecemeal, showing that it exerts its effects even in an otherwise pristine universe. According to the standards that rule the profession, a GE model with one twist is theory’s version of the controlled experiment. This is why the picture Eichengreen paints for us, in which multiple unorthodox insights come together and interact synergistically, is never seen in a peer-reviewed economics journal. As a result, even though every organ of 1960's-era orthodoxy is mortally wounded, the entire body strides vigorously forward. That is a prime reason why, despite the labors of so many clever and right-thinking economic theorists, we are in this mess.
Second, the shift toward empiricism is not an unalloyed gain. Yes, much of this work is refreshingly open-minded, allowing the data to lead. An honest tally of the published literature, however, particularly in the top journals, will show that a majority of quantitative articles are concerned to calibrate existing theoretical models. Unless a model is so out of step or inflexible that it cannot be calibrated at all, it passes the empiricist’s “test”. Economics, as I have argued before here and elsewhere, has no culture of what in real sciences is known as a critical test, a confrontation with data that can be survived only if the hypothesis in question is highly likely to be correct. In other words, empirical work in economics, whatever sophisticated estimators it employs and stringent p-values it seeks, has little to do with the minimization of Type I error, properly understood. For this reason, bad theory (like the mind-numbing onslaught of DSGE models in macro) prosper even in the midst of the “empirical turn”. With enough tweaking, I can calibrate an equilibrium model of the US economy as of 2006, and again as of 2009. It won’t be exactly the same model, but it will use a standard set of baseline assumptions, so who cares?
The bottom line is that economics in both its theoretical and empirical modes is implicated in the current debacle. Making the funding of economists more transparent would help, and attention should be given to the institutional structures that favor conformism within the profession, but economics itself needs to be reformed.
Economics, as I have argued before here and elsewhere, has no culture of what in real sciences is known as a critical test, a confrontation with data that can be survived only if the hypothesis in question is highly likely to be correct.
This, I feel, is crucially important issue. Too many economists seem to be completely ignorant of the notion of falsifiability. Here I will limit myself to quoting Karl Popper.
Science: Conjectures And Refutations
by Karl Popper1. It is easy to obtain confirmations, or verifications, for nearly every theory — if we look for confirmations.
2. Confirmations should count only if they are the result of risky predictions; that is to say, if, unenlightened by the theory in question, we should have expected an event which was incompatible with the theory — an event which would have refuted the theory.
3. Every "good" scientific theory is a prohibition: it forbids certain things to happen. The more a theory forbids, the better it is.
4. A theory that is not refutable by any conceivable event is non-scientific. Irrefutability is not a virtue of a theory (as people often think) but a vice.
5. Every genuine test of a theory is an attempt to falsify it, or to refute it. Testability is falsifiability; but there are degrees of testability: some theories are more testable, more exposed to refutation, than others; they take, as it were, greater risks.
6. Confirming evidence should not count except when it is the result of a genuine test of the theory; and this means that it can be presented as a serious but unsuccessful attempt to falsify the theory. (I now speak in such cases of "corroborating evidence.")
7. Some genuinely testable theories, when found to be false, are still upheld by their admirers — for example by introducing ad hoc some auxiliary assumption, or by reinterpreting the theory ad hoc in such a way that it escapes refutation. Such a procedure is always possible, but it rescues the theory from refutation only at the price of destroying, or at least lowering, its scientific status. (I later described such a rescuing operation as a "conventionalist twist" or a "conventionalist stratagem.")
One can sum up all this by saying that the criterion of the scientific status of a theory is its falsifiability, or refutability, or testability.
Economics Was OK, It Was Only the Economists who Failed.
or as English Northerners say in a popular phrase:
A poor workman always blames his tools.
It seems to me the problem is that empirical models have little to no predictive capability. Well i guess they might in an equilibrium or a steady state situation, but even a simple economy doesn't really fit the qualifications for steady state.
Empirical work is generally difficult to extrapolate even in sciences where the background assumptions are relatively accurate.
If a poor workman made his tools, he may have good reason to blame them.
Well - it took me a long time to understand the implication.. a good workman takes care of his tools and makes sure he's always got ones that are up to the job. I think economics is like teaching. Either your good at it or your not. Some people just have a nose for it. Joseph Stiglitz springs to mind, predicting a global depression by 2009 way back in 2006...
Modern economics plays the role of ancient shamanism. We just have to believe the experts and rituals.
"I think economics is like teaching. Either your good at it or your not."
That statement may apply to any and all activities that require some degree of intelligence. In effect the statement has no consequence. The problem is not whether an individual economist, or a group of similar mind, is good or bad at the craft. The problem is that the profession is as much craft as it is science and this characteristic leaves much room for obfuscation. The field of economics is too closely financially tied into the industry it most seeks to "study" and influence, financial services. We have become increasingly aware of the dubious value of research conducted by medical scientists who are closely allied with the pharmaceutical industry. The results of their research is seen as possibly tainted by the potential for financial gain. The same applies to economics, but on a much grander scale because the enrichment of the individual participants is so phenomenal.
The subject of economics has as much right to call itself a science as the vocation of bible study has to call itself a science.
Economics belongs in the theology wing.
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