
How Effective Is Economic Theory? - abhineet97
http://www.nationalaffairs.com/publications/detail/how-effective-is-economic-theory
======
dhfhduk
Discussions like this always seem a little strange. Sure, they're important,
but taken out of context they're counterproductive and even harmful.

This is the problem: what is the alternative? The pet theory of a madman or
sociopath?

The difficult truth is that everyone has an economic theory, whether they
admit it or not. The question is, whose theories do we want to pay attention
to? People who spend their lives arguing and thinking about it, and trying to
find some evidence in support? But who might be a bit isolated from reality?
People who work close to the phenomena being explained, but who don't really
rigorously explicate or defend any of their ideas, who haven't had to put them
on the table, so to speak? Or have massive, critical financial conflicts of
interest?

There's also the difficult problem of identifying when any theories have
really been tested well. It's not like we can just run randomized controlled
designs on whole civilizations--at least, not most of the time for major
policies.

I guess I really don't see the alternative to encouraging the standard
academic approach to economics, opening it up to public criticism and
discussion, and maybe trying them out when it's ethical and feasible.

Sure, lots about classical economic theory is really ridiculous, and the
source of a lot of problems, but then you change those things and then move
on. It's not any different from physics theory or chemistry theory in that
regard.

~~~
paganel
> Sure, lots about classical economic theory is really ridiculous, and the
> source of a lot of problems, but then you change those things and then move
> on.

That's the thing, it has proven really, really hard to "change those things".
I'm looking at the latest (still current?) economic/financial crisis. Lots of
"economic theory tells us this should never happen"-things did in fact happen,
and consistently so (there was not just a random event that you could blame in
the theory not being 100% there). It matters because policy decisions are
still taken based on theories that have proved themselves wrong, or at least
those theories were not able to "explain" (for a lack of a better word) how
our present-day economy works. Those policy decisions affect (some of them
negatively) the lives of millions, even hundreds of millions.

At least when a theoretical physicist is wrong in his/her assessment nothing
that bad can happen to the outside world, in the great scheme of things. But
when an economist is wrong, but his theory is nevertheless taken into
consideration and acted upon, then the damage can be quite substantial, its
effect measurable in decades.

I don't know what needs to be done. I'm not ditching economic theory entirely.
For example the Chinese authorities' current push to stop Chinese
billionaires' money moving outside the country reminded me of Jean-Baptiste
Say's explanation of how no Government can put a stop to the flow of currency
that wants to escape a certain jurisdiction, a phenomenon that he wrote about
~200 years ago and which still seems to be in effect, almost like a "law" of
economics. And there are still other "basic" economic truths/laws that have
seemed to keep their relevance over the centuries. But, AFAIK, almost all of
those "laws" were common sense, so to speak, they didn't involve mathematiac
equations with second derivatives and the like (for example there's no "second
derivative" equation with which to model the "lack of trust" in financial
transactions, which once it sets in you can bet will bring any financial
market down pretty fast).

So what I'm trying to say in a convoluted way is that economics should return
to basics, ditch most of the mathematics with which it has become enamored and
try to be a little more on the "social science"-side of things: more
observation of humans and their acts, less abstract computations.

~~~
paulpauper
I think you're overestimating the power of economists and putting too much
blame on them. The 2008 crisis was not cased by economists; rather, it was
caused by MBAs who approved mortgages that should have never been approved in
the first place. This generated short-term gains for these financial
institutions that paid the price years later.

~~~
woodandsteel
>it was caused by MBAs who approved mortgages that should have never been
approved in the first place.

But the point is the economists should have seen that was happening, so we
could think about the government stopping it, or at least to put the public on
guard. Instead the economics profession, with a few exceptions like Dean
Baker, told the world that things were going just fine.

I mean, what is the point of even having an economics profession if it can't
help us make intelligent decisions on economic matters?

~~~
dragonwriter
> But the point is the economists should have seen that was happening

A large number of economists (in academia, public institutions, and private
finance firms), all across the ideological spectrum (Austrians, Keynesians,
and every other flavor) did see it happening.

People didn't respond to then, probably because the existence of a bubble
isn't a problem, as long as you can delude yourself to thinking you'll be able
to time the market so you won't be holding the ball when it pops.

> Instead the economics profession, with a few exceptions like Dean Baker,
> told the world that things were going just fine.

Baker was far from the only prominent economist pointing to a bubble. In fact,
economists were warning about the housing bubble and the fact that it would
have to burst before the first dot-com bubble burst (or even expanded) back as
far as the mid-1990s. That may actually be the real problem: the warnings had
been around for so long no one took them seriously any more; as controversial
as identifying a bubble can be, it's a lot easier to identify it than time
when it will pop ,and the longer it is pointed to without popping, the more
likely people are to convince themselves it's just a permanent feature of the
market and not a bubble that will pop.

~~~
Terr_
> A large number of economists [...] all across the ideological spectrum [...]
> did see it happening.

In a strange way, that's almost step down: A _strong_ correlation between what
economists say and what happens -- even a _negative_ correlation -- suggests
that theory is somehow catching up to reality.

In contrast, a weaker correlation -- even if positive -- implies that there's
still a lot more problems to shake out.

------
bmh_ca
Effective at what?

A rather savvy economic-statistician once told me that economic theory is a
very effective way to determine who has been able to get their theory
published.

~~~
rhizome
Not only that, but the current economic climate necessarily tells us where the
effectiveness of economic theory lies.

~~~
TheSpiceIsLife
Not Economic Theory, but Economic Practice as implemented by politicians and
bureaucrats.

That's not to say that economic theory is all sound, but that even the
soundest of theories doesn't stand a chance against the incompetence of
government.

~~~
rhizome
The "incompetent" economic behavior you speak of is also based upon theory.

------
szeptik
When it comes to macro, it is pretty useless. See for example the polemic
caused by this paper by Paul Romer, chief economist of the World Bank:
[https://paulromer.net/trouble-with-macroeconomics-
update/](https://paulromer.net/trouble-with-macroeconomics-update/)

~~~
bachmeier
If that's what you took from his paper, you didn't understand it. He is
specifically arguing against DSGE models, a popular methodology for studying
business cycles, but one that has been unsuccessful. That is not the same as
arguing that all of macro is useless. It's not different from saying that
criticism of imperative programming means all of computer programming is
useless.

~~~
marcosdumay
If the community does not take status and funding away from failed models, it
ceases doing science. As a group, economists aren't letting DSGE go.

There are many economists trying to do the right thing, but overall the area
has a deep problem.

~~~
nostrebored
Do you feel the same way about climate research?

~~~
marcosdumay
Climate researchers abandon models all the time.

~~~
nostrebored
Necessarily, as none of their models work, which is a natural consequence of
how complicated the system is, just like macroecon.

------
armenarmen
Reminds me of a quote by Steven Landsburg: > Most of economics can be
summarized in four words: "People respond to incentives." The rest is
commentary.

------
frgtpsswrdlame
This is a great article although the stuff about Austrian economics and how
economics will move left should be tossed. Mr. Kling should save those
opinions for Cato.

Aside from that, I always wonder why we have never had a "Great Economic
Project." In WWII we united scientists of all stripes to come together to
build the atom bomb and more recently Obama launched the BRAIN initiative.
Understanding how our economy works is, I'd say, as important as either one of
those. Some project where the government can assemble the best minds in
sociology, psychology, business, math, history and then use economists to help
glue all of this together. Perhaps our way forward is not in coming across
some new beautiful model but in building the ugliest, most glued-together
piece of crap that happens to be (relatively) accurate and then simplifying it
later.

~~~
jerf
'Aside from that, I always wonder why we have never had a "Great Economic
Project."'

The nature of politics is such that if the government funded such a thing, the
only acceptable outcome for it to come to is that the people funding it
already had the correct model. The alternative is that the politicians funding
it would have spent a lot of political capital to get that funding only to be
told that they're wrong, probably wrong about everything.

On one level or another, even politicians realize that they might as well just
cut out the middleman here and operate on the vigorous and loud assumption
that they are already correct about economics and anyone who disagrees is the
literal embodiment of evil.

------
noir-york
It is pretty effective as long as you ignore the economic theories espoused by
the Cato institute (the institution the author forms part of) and other pseudo
think-tanks.

Interesting to note that the author tries to discredit Keynesian economics,
but makes no mention of the Reinhart / Rogoff debacle that completely
undermined their paper which purported to show a link between debt and growth
- a paper much referenced by people like the author of the article who are
primarily interested in using economics as a fig leaf for their ideology.

For the record, I trained in politics and economics.

~~~
partiallypro
I also trained in politics and economics, and worked for a think-tank doing
economic impact analysis for a short period. And I will tell you that Cato has
a lot of good economists, that are well respected in their field; so do -most-
think tanks, and Federal Reserve branches. Every economist has a political
view, largely because economic policy is largely political. Krugman is a
political hack, but that doesn't mean his papers are trade can be discounted,
that would be absurd.

The reason economic theory is so hard is because it's very hard to observe and
experiment. You can run a test and verify in physics, math, etc, but in
economics this is generally impossible. Even the boom in behavioral economics
that happened in the mid-2000s has come under question after more and more
data has emerged. There are a LOT of things economists agree on, but there's
also nuances on how a policy can achieve a result...because there are so many
actors in an economy and we can't test our theory until maybe 10 years from
now, and that's even if the policy is ever implemented to begin with.

------
maxxxxx
I know the economy is much more complex than let's say physics. But at least I
would like economists to backtest things that happened. For example, the large
tax cuts that happened during the Reagan, Bush and probably Trump years could
be tested and it could be determined if the promised increase in investment
and whatever really happened. At least the economists that make it to the
media don't seem to have interest in checking whether their theories actually
worked out.

~~~
pzone
Backtesting is a poor substitute for experimentation. We can't run back
history and check what happens if the Bush tax cuts never happened. We
certainly can't create a thousand parallel economies, implement the tax cuts
in half the sample and not in the other.

Economists use historical data to calibrate models. Of course data from the
Reagan years was used to are for the Bush tax cuts. But simple backtesting can
never tell you with certainty wherever your theories worked out or not.

------
tnecniv
I'd be interested in hearing someone with knowledge talk about how these
models get used in practice. From an engineering perspective it seems like
actually applying them would be very hard.

For example, how good are parameter estimates and how do we know if they are
good? If I was designing a controller for a plane, I can spend a lot of time
getting good parameters for the plane model and design a controller that looks
good in simulation. However, when I take the plane out, it might not be stable
(or doesn't meet some other metric I designed for) because the parameters
changed due to a variety of physical factors and/or the model is a model and
thus doesn't account for anything. So I go back and forth tweaking the
controller design until I get something that works. That process isn't really
feasible when it comes to economies, though.

~~~
pzone
Economic models usually aren't used for precise, high-frequency decision-
making. When you estimate an economic model, simply getting the right sign on
your estimates is often enough to inform your decision. Choosing what to take
as exogenous is a matter of judgment.

Would building high speed rail from NYC to Chicago be a net positive for
consumer welfare? Well we can use estimates of how much people pay for various
modes of transportation throughout the country, and how often they're used. We
can also come up with an estimate of the cost of building the rail. The
analogous effects to your feedback loop are equilibrium effects - for example
if people start taking the new high speed rail then plane ticket prices will
fall a bit. But it adds more uncertainty to the model, and we know that plenty
of flights from NYC to Chicago are connecting flights, so probably the effects
are pretty small, and we can just assume those prices stay fixed for the sake
of tractability.

If you do this kind of calculation and find the rail project is a massive
multi billion dollar money pit, you can confidently recommend against it
despite the fact you've ignored some of the feedback effects.

------
jostmey
While in graduate school for biology, I gained a limited exposure to the
economics department through some of the students. I saw very little actual
"tracking on money" and a whole lot of conjecturing and mathematics. It seemed
like lots of theory and not very many facts

------
grenoire
People most often overlook two things when it comes to economics.

First one is that it is based on drawing conclusions from models that attempt
to simplify extremely complex interactions of billions of agents.

Second one is that although these models are imperfect (otherwise they would
be unsolvable and bring no meaningful intuition), they are getting better over
time.

Stop dismissing economics because 'it doesn't work.' The subject of the
science simply doesn't have any determinism to it whatsoever, and things
aren't reasoned through discovery as it is the case with natural sciences.

~~~
sloppycee
How can you be sure the models are getting better (more accurate) over time?

------
quantum_state
An interesting article ... but not sure it's that accurate to compare
economics to physics ... the closest situation comes to mind would be the
phenomenon of turbulence ... which still is more manageable than economics
since the controlling principles are known and controlled experiments can be
performed ... on the other hand, an economic system involves many many agents
of different scales, most of time seemingly rational but certainly emotional,
interacting nonlinearly at all scales, without much chance of controlled
experiments ...

------
crdoconnor
>This notion of effective theory sets a useful standard for considering
economics. Economists are not without knowledge. We know that restrictions on
trade tend to help narrow interests at the expense of broader prosperity.

We know that there aren't any countries which rose to first world status
_without_ judicious application of tariffs, subsidies or currency
manipulation.

~~~
euyyn
Is that causation, or only correlation?

~~~
crdoconnor
Causation:
[https://en.wikipedia.org/wiki/Infant_industry](https://en.wikipedia.org/wiki/Infant_industry)

------
AnimalMuppet
"There is a very real possibility that over the next 20 years academic
economics will congeal into a discipline, like sociology today, which is
definitively shaped by an ideologically driven point of view."

That does not bode well for the future of the economy...

------
cs702
No respectable author would dare ask such a question about the effectiveness
of, say, theoretical Physics, Computer Science, or the Theory of Evolution --
to name other bodies of theory familiar to general audiences.

The fact that the question is being asked about Economic Theory in a
respectable, prominent magazine like National Affairs provides the answer.

~~~
CalChris
Provides _what_ answer? Is _National Affairs_ a _respectable, prominent
magazine_? I'd never heard of it. Founded in 2009, it has a circulation of
about 10,000 [1]. At $27.99/yr, it clearly doesn't pay for itself. It looks
like a small media outlet, a sinecure for right wing writers and editors, and
financially supported by Irving Kristol [2].

[1] [https://newrepublic.com/article/112745/yuval-levin-rights-
ne...](https://newrepublic.com/article/112745/yuval-levin-rights-new-irving-
kristol)

[2]
[https://en.wikipedia.org/wiki/National_Affairs](https://en.wikipedia.org/wiki/National_Affairs)

------
acd
A flaw with current economics is that they expect the economy to grow
exponentially while resources including energy are linear. That for me is a
flaw can someone explain how that
works?[https://dothemath.ucsd.edu/2012/04/economist-meets-
physicist...](https://dothemath.ucsd.edu/2012/04/economist-meets-physicist/)

Then there is central banks which I think is a form of central planning. Most
central planned system lack information that why they do not work. I argue
production of goods and services are free market but money creation is
centralized by banks and central banks.
[https://en.m.wikipedia.org/wiki/Economic_calculation_problem](https://en.m.wikipedia.org/wiki/Economic_calculation_problem)

Then there is the whole thing of peels bank act where the bank loans your bank
account assets to others no matter how risky but still guarantees it to you.
Is banks doing a form of double book keeping?
[https://en.m.wikipedia.org/wiki/Bank_Charter_Act_1844](https://en.m.wikipedia.org/wiki/Bank_Charter_Act_1844)

~~~
JumpCrisscross
> _A flaw with current economics is that they expect the economy to grow
> exponentially while resources including energy are linear_

The amount of energy the world consumes to produce 1 unit of GDP declined by
32% between 1990 and 2015 [1]. Measuring macroeconomic material intensity is
more complicated [2], but the core of your misconception derives from the
subjectivity of value.

One way to make a car more valuable might be to make it twice as heavy. But
another could be to make it a nicer color. Or give it better software. (Better
being defined solely by price.) As our world becomes immaterial, the
decoupling of material inputs and economic output makes sense. It also lays
the ground for theoretically infinite economic growth. As long as peoples'
utility is being increased the economy will grow.

[1]
[https://www.eia.gov/todayinenergy/detail.php?id=27032](https://www.eia.gov/todayinenergy/detail.php?id=27032)

[2]
[http://www.sciencedirect.com/science/article/pii/03014207859...](http://www.sciencedirect.com/science/article/pii/0301420785900455)

