March 9, 2010

Economics Is on the Verge of a Golden Age

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Home Opinion & Ideas The Chronicle Review
The Chronicle Review
March 7, 2010
By Diane Coyle
Progress in any science depends on a combination of improved
observation, measurement, and techniques. The cheap computing of
the past two decades means there has been a tremendous increase
in the availability of economic data and huge strides in econometric
techniques. As a result, economics stands at the verge of a golden
age of discovery.
You might be surprised by that statement, especially if you’ve been
following the general debate about the role the discipline has played
in the economic crisis. With Paul Krugman, in his New York Times
article “How Did Economists Get It So Wrong?,” at the forefront of
the attack last autumn, certain prominent journals and blogs have
given their readers the impression that economics is in a state of
catastrophic intellectual collapse.
I’d better start with the question of why those attacks are so wrong.
Krugman’s controversial article contains many statements that are
either inaccurate or tendentious—starting in the opening
paragraphs with the claim that “few economists saw our current
crisis coming.” In fact, many economists predicted the crisis,
including, famously, Raghuram Rajan, Nouriel Roubini, Robert
Shiller, and Martin Feldstein in the United States, and Roger Bootle
and Andrew Oswald in Britain. Those were not lone voices. It is not
economists’ fault that policy makers chose not to act on the many
warnings of unsustainable global economic imbalances and
financial-market excesses.
However, it’s not my aim to pick apart specific claims made by
Krugman or any of the other commentators who’ve used the crisis to
attack economics. Several excellent articles elsewhere do that,
including those by John Cochrane, Robert Lucas, and Casey
Mulligan. Rather, I’ll make two points about the general nature of
the criticisms of economics and economists before turning to the
impressive developments in the subject in recent years.
The first point is that all of the recent critiques assume that
macroeconomics defines economics. In fact, macroeconomics—the
study of the economy in the aggregate—is just one part of the
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subject. Most economists are microeconomists, specializing in the
study of small parts of the whole. Macroeconomics is, of course,
both prominent and important because it is needed to set monetary
and fiscal policy appropriately. At what level do interest rates need
to be? Is unemployment higher than it needs to be, and how can the
government reduce it? Some macroeconomists say that their branch
of the profession has responded pretty well to the crisis, managing
successfully to avert a much more serious downturn. Indeed, Fed
Chairman Ben Bernanke and his counterparts in other central banks
have followed standard prescriptions from the macroeconomic
textbooks in ensuring we did not get a repeat of the Great
However, it’s glaringly obvious that macroeconomics is far from the
settled realm of hard knowledge. On the contrary, it is the muddy
terrain of partisan political warfare, as demonstrated by the grilling
this winter of Bernanke and Treasury Secretary Timothy Geithner in
Senate committee hearings, and by the furious left-right sniping
worldwide about how quickly government budget deficits need to be
reduced. Last spring’s spat about Treasury-bond yields, of all things,
between Krugman (again) and the economic historian Niall
Ferguson, demonstrates well the passion and bitterness involved.
That political dimension of macroeconomics is a return to the norm,
subverting the consensus of recent years, which turns out to have
been a symptom, rather than a cause, of what’s become known as
the Great Moderation, a rare period of stable growth and low
The absence of agreed-upon analysis and policy prescriptions
reflects the fundamental difficulty of what macroeconomists are
trying to do, namely understand and predict the decisions of
millions of people who are all influenced by what other people do.
Macroeconomic forecasting is often compared to weather
forecasting—both involve nonlinear dynamic systems or, in other
words, a number of interrelated variables that change over time in
ways that themselves change. Actually, the state of the
macroeconomy is even harder to predict than the weather because
raindrops don’t read about one another in the news or try to avert a
drought by adopting a cloud-seeding policy. The economy as a
whole is not prone just to self-fulfilling or herding tendencies, like
any complex system in nature, but to self-reflective ones, too. The
eminent Cambridge economist Sir Partha Dasgupta has written: “It
is a recognition of the commonality of the human experience, on the
one hand, and the separateness of every human being and the
particularity of the circumstances she faces, on the other, that gives
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economics its special flavor and is a reason why it is an awesomely
difficult subject.”
Given that macroeconomics is both necessary and difficult, those of
us who are not macroeconomists might hope for a somewhat more
diffident tone from those who are. It would be a vain hope, sadly.
It’s not just that the macroeconomic arguments make for great
ammunition in a political debate. There are also too many
macroeconomists employed in the financial markets to generate PR,
or help out their traders, by forecasting whether GDP growth will be
0.3 percent or 0.4 percent this quarter.
A more realistic hope would be to reform the macroeconomics
curriculum. Previous attempts to shift the teaching of economics at
the graduate level away from its undoubtedly narrow focus,
involving a particular technical approach, have foundered. When it
comes to macroeconomics, too much reliance has been placed on a
certain type of economic model that cannot incorporate the kinds of
feedback and herding behavior we know occur, nor take account of
the ways the structure of an economy changes as a result of new
technologies, for example. Technical rigor is a strength only if it is
accompanied by an acknowledgment of its limitations. The welltrained
economist should be aware of economic history and findings
from the other social sciences. Some are, no thanks to a curriculum
that has narrowed over the decades. But David Colander of
Middlebury College, a leading advocate of such reform, is relatively
optimistic in his latest books about the way the teaching of the
subject is moving. My conversations with many academic
economists on both sides of the Atlantic also lead me to believe
there is a strong appetite for updating the curriculum.
The second general point to make about the current wave of attacks
on economics is that all have in common a distrust of its use of
mathematical modeling in general. Astonishingly, that group
includes even Krugman, who in a previous existence (see his 1996
Slate article called “Economic Culture Wars”) defended the essential
role of mathematics in economics. (He has claimed his recent Times
article on the matter was misinterpreted, but if so it is a
misinterpretation hard to avoid. There he wrote: “The economics
profession went astray because economists, as a group, mistook
beauty, clad in impressive-looking mathematics, for truth. … The
central cause of the profession’s failure was the desire for an allencompassing,
intellectually elegant approach that also gave
economists a chance to show off their mathematical prowess.”)
The math is important because it enforces logical consistency and
provides the scaffolding for testing hypotheses against evidence.
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“Common sense” is well able to ignore accounting truths, like the
fact that if the United States wants to reduce its current account
deficit while its government budget deficit is increasing, then
private saving has to increase and private spending has to decrease
(a lot). That, in turn, would constrain what’s usually called demand
management. Without the formalism of mathematics, game
theory—the study of strategy—would not exist. Nor would
econometrics, the statistical testing of economic hypotheses. There
would, in short, be no scope for scientific discovery.
For many critics of economics, the real objection is in fact this very
notion of applying the scientific method to any aspect of human
society, including economic transactions. I’ve concluded that it’s an
emotional response, similar to the so-called “yuck factor” that many
people feel about seemingly “unnatural” biomedical innovations like
face transplants, or transplanting animal organs into humans.
That is not to say that economics deserves no criticism. Certainly in
the early 1980s, many of the charges made by its critics—the
simplistic assumptions about human psychology, the excessive
belief in the benign properties of markets, the conflation of general
self-interest with narrow selfishness, the reliance on an unrealistic
application of rational calculation in decision making—were valid.
That was the high-water mark of free-market individualism in
economics, just as it was in politics.
But that was three decades ago. A whole generation of economists
has since transformed the subject into exactly what its critics are
now saying it ought to become. Oddly enough, some parts of the
recent research agenda have caught the public imagination. For
example, behavioral economics is firmly lodged there thanks to
popular books ranging from Shiller’s Irrational Exuberance to
Richard Thaler and Cass Sunstein’s Nudge. The economics of
“happiness” is another area that has caught on. In both cases, critics
imagine that these areas of research “disprove” economics. Never
mind that economists themselves are at the forefront of both.
The behavioral approach has gained wide acceptance in the
profession because in some areas of decision making it has
empirical validity, and most economists are empiricists. It is by no
means seen as overturning all previous economic research. On the
contrary, there are other areas of decision making where
conventional economics has far greater empirical traction. For
example, auction theory has helped governments raise billions of
dollars from using market-based mechanisms to sell access to scarce
resources like the broadcast spectrum or oil. “Market design” based
on game theory has been widely used to improve the way job
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markets operate or to set up e-commerce platforms. “Happiness”
economics is more contentious in the profession, and recent
research (by Angus Deaton, and by Betsey Stevenson and Justin
Wolfers) has cast serious doubt on the claim that economic growth
does not increase happiness. The new research points out that it is a
statistical error to expect happiness (measured by the limited
options in a survey question: Would you say, generally speaking,
that you are very happy, happy, or not very happy?) to rise in
proportion to GDP (a statistic that can increase without limit). But
the happiness literature has nonetheless helped spur a revival of
serious interest in welfare economics.
Other areas of recent research are not yet quite so familiar. The
2009 Nobel Memorial Prize awarded to Elinor Ostrom and Oliver E.
Williamson brought to wider attention the exciting work on
institutional economics. That is the study of the ways economies are
organized, either through informal rules such as sharing water and
pasture, as in Ostrom’s case, or by formal institutions such as
business corporations, as in Williamson’s. But there are other areas
so far entirely neglected outside the economics profession,
especially by those whose aim is to criticize the subject.
An astonishing explosion of creativity and intellectual progress has
been under way for years in a number of areas. Consider
competition economics (should the Department of Justice challenge
the Google Books settlement on antitrust grounds?), the application
of game theory or the use of market design (what’s the best system
for matching newly qualified doctors or Ph.D.’s to jobs?),
development economics, the economics of technological change and
network markets (what prices should mobile-phone companies
charge for access to one another’s networks?), and the study of longterm
growth. Or technical areas such as the development and
application of experimental methods, innovation in econometric
techniques (for instance, how should the empirical assessment of a
policy take proper account of gaps in the data or variables that can’t
be observed?).
Economists—microeconomists—doing this kind of work are well
aware of and able to live with the messiness of real psychology and
institutions. Market imperfections are their bread and butter. So,
for that matter, are government imperfections. For both markets
and governments will often “fail” in similar situations, because of
asymmetric information or transactions costs, factors that
frequently make economic policy difficult. For example, how can
economists factor in the incentive people have to lie about their
health to get insurance? Some groups might not be able to get
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The Chronicle of Higher Education 1255 Twenty-Third St, N.W. Washington, D.C. 20037
coverage at all, whatever their individual characteristics. But even if
the government steps in to provide insurance where the market
fails, incentives to lie remain and will make the scheme inefficient.
It takes an economist to analyze the details of a particular market or
government policy with the necessary rigor. Such work is often
highly mathematical and technical, not abstract and unrealistic.
The balance economists should seek is between rigid mathematical
modeling that disregards the human element and a math-phobic
generality that’s too abstract to apply to real-world problems.
The growing availability of data online and the collection of new
data mean that for the first time it is becoming possible to advance
economic knowledge in the robust and detailed manner that’s
familiar from other sciences. Economics is at the dawn of an age of
discovery. That will be accomplished incrementally, rather than in
headline-grabbing grand theories about how the economy ticks as a
whole. It will consist of evidence about particular markets, people,
places, times. But it will improve policies and the way we organize
our societies.
Buck up, economists. Before long you’ll defy your ill-informed
Diane Coyle runs the London-based consultancy Enlightenment
Economics and is a visiting professor at the University of
Manchester. The revised edition of her book The Soulful Science:
What Economists Really Do and Why It Matters has just been
published by Princeton University Press.
Copyright 2010. All rights reserved.
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