It’s Dismal Alright But Is It Science?

At the LA Times scholar John Ioannidis leaps to the defense of economics:

The financial crises of the past two decades, and our failure to predict them, have wreaked havoc on more than just the global economy. The bursting of the dot-com bubble in 2000, the Enron scandal and the global financial crisis of 2008 have led to a loss of faith in economics itself.

But these crises and scandals do not mean that the science of economics is inherently unreliable. Most of them occurred because we ignored what we knew.

He goes on to point out two of the problems: people with lots of money don’t necessarily know anything about economics and, consequently, are not good sources of economic advice and politicians are even worse.

To these I would add three more. First, economics is inherently politicized. Anything that involves money inevitably will be. The second is something I complain about routinely here: you will always find economists who are willing to twist their economic judgment to further political goals.

The last issue is that economics is only weakly predictive. We can calculate with enormous precision what it takes to put a satellite into orbit or produce a pharmaceutical. Economists can generally tell you the directionality of events but can’t tell you how much or when with any precision.

That’s still useful because it gives you insight into the domain of the likely outcomes of this change or that. Perhaps if economists become more empirical things will get better but that hasn’t been the trajectory of economics for the last century. That’s been more towards mathematicalization than about observation.

7 comments… add one
  • Steve Link

    They were loaning billions of dollars to people without confirming that they had income. Did it really require an economics degree to know that would end badly?

    Steve

  • Guarneri Link

    “Did it really require an economics degree to know that would end badly?”

    No. “They” needed fewer politically motivated policy incentives; dictates of home ownership for everyone and a government entity to offload your bad loans don’t work. “They” needed regulators who weren’t bludgeoned by politicians; it’s easier to offer candy than admonish to eat your broccoli. “They” needed to suffer the consequences of offering bad credit; don’t force taxpayers to bailout politicians, brokers, investors and lenders. “They” needed to suffer the consequences of seeking bad credit; don’t force taxpayers to bailout greedy or incompetent borrowers.

    What economics has to do with Enron, housing bubbles or equity bubbles escapes me. But I sure do understand human nature.

  • PD Shaw Link

    From this excerpt it sounds like “economics” means business, finance or market analyst.

  • “They” needed regulators who weren’t bludgeoned by politicians

    Sadly, difficult as that is, it’s not enough. Just to take a single instance, banks have more to offer regulators than the government does. An ambitious bank regulator will ultimately go easy on the banks he’s notionally regulating with a career plan of getting a lucrative job with a big bank in one, two, or five years.

    Regulatory capture, as it’s called, isn’t just a problem for the SEC or the Federal Reserve. One of the causes of the Gulf oil spill of a few years ago was that the (now no longer extant) agency tasked with regulating the oil companies was notoriously under the thumb of those companies.

    No one seems to like my solution to the problem of regulatory capture: break up big banks, big oil companies, etc. until they’re no longer big enough to have a lot to offer. Neighborhood banks don’t offer multi-million dollar sinecures to former Treasury or Federal Reserve officials.

  • mike shupp Link

    Intriguing post. Makes me wonder.

    Perhaps we’re doing the wrong things with economics and should be looking at different modes of analysis, different variables. A comparison I might draw is with rocketry — there are equations and variables to describe the physical state of a rocket — its velocity, its position, the gravitation attraction of earth and other planets, etc. Which works reasonably well. But we can also describe a physical system with thermodynamics — calculate temperature and enthalpy and so on. And while this is of some interest, it’s kind of pointless when you want to answer questions “When will the Soyuz reach the ISS?” I kind of get the impression modern economics, or at least macroeconomics, is much more interested in viewing the economy sort of like a thermodynamical system, rather than viewing trajectories of diverse firms.

    Maybe we could start over?

  • Guarneri Link

    “Sadly, difficult as that is, it’s not enough.”

    That’s fair, but it takes both. I’ve told these stories before. I watched with my own two eyes as regulators informed the credit side of the bank that they could either go up in rating, or down in rating, (which affects reserves and therefore costs) for audited credits depending on CRA compliance to, ahem, “guidelines.” Not to mention regulatory approvals of mergers. And I bet if one is ambitious one can still find the CSPAN footage of the withering criticism of regulators by Congressional committees for daring to suggest that public policy was at odds with good credit.

    As for your solution, I think you need to grapple with why the companies got large. I doubt it was designed to facilitate regulatory capture. Further, should the solution be to chop up companies, or quit leaning on compliant government regulators. This is where tort law comes in.

  • I think you need to grapple with why the companies got large.

    The first really big companies in the United States were the railroads. They became big through exclusive franchises granted to them by state and local governments.

    Standard Oil became big because of John D. Rockefeller’s government contracts (and war profiteering) during the Civil War. General Electric became big because of patents (hypothetically limited term government-granted monopolies). The banks have become big because of the various different protections they’ve been given by government at various levels.

    Jumping forward to more recent times, Microsoft is big because of copyrights (another government-granted monopoly). Google’s basic business model relies on their ability to sell data which under a natural law model would not belong to them. The EU’s recent changes in regulations governing data may put Google out of business there.

    I honestly don’t know how Facebook has become big. Basically, wishful thinking I suspect. I don’t believe that its revenue-generating ability really justifies its stock value. You might want to check out Apple Computer Co. Inc. v. Franklin Computer Corp.. That Apple has become the company it is now because it’s been helped by the government is hardly deniable.

    And so on. Companies can become pretty big by making products that people want to buy but becoming really big requires help from government.

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