Historians versus Economists?

Gideon Rachman had a really abominable article in the FT. It is not his call for economists to become less vain that I have trouble with:

The vanity of economists needs to be challenged. Above all, their claim to scientific rigour – buttressed by models and equations – must be treated much more sceptically.

I am not really sure who is so vain. But the use of models and equations is of course misunderstood here. Models and equations are used to make arguments understandable, not to pretend. But this is not the worst. Rachman quotes Stiglitz calling for new paradigms in economics, and then argues:

For somebody educated as a historian, there is an obvious alternative conclusion to draw from Prof Stiglitz’s opening observation. And that is to conclude that the entire attempt to treat economics as a “science ... defined by its ability to forecast the future” is misconceived.

Economics is not about predicting the future. That is a straw man. It shows how little Rachman understands about economics. Fortunately, his FT colleague, Tim Harford has a good column that deals with this. Here is the money shot:

Historians deal in hindsight. It is a wonderful thing. But it is not the only thing. I wonder whether Gideon, intoxicated with a heady brew of Niall Ferguson and Herodotus, has forgotten that.

Brooks on Economics

David Brooks had an article in the New York Times today on the future of economics. It is the usual stuff about how economics was too narrow but the financial crisis will make it better as economists become humanists:

Economics achieved coherence as a science by amputating most of human nature. Now economists are starting with those parts of emotional life that they can count and model (the activities that make them economists). But once they’re in this terrain, they’ll surely find that the processes that make up the inner life are not amenable to the methodologies of social science. The moral and social yearnings of fully realized human beings are not reducible to universal laws and cannot be studied like physics.

Once this is accepted, economics would again become a subsection of history and moral philosophy. It will be a powerful language for analyzing certain sorts of activity. Economists will be able to describe how some people acted in some specific contexts. They will be able to draw out some suggestive lessons to keep in mind while thinking about other people and other contexts — just as historians, psychologists and novelists do.

At the end of Act V, economics will be realistic, but it will be an art, not a science.

Greg Mankiw explains some of the flaws of the article.

I could nitpick this article forever, but one important point I think is that Brooks confuses what sells in the wider market for what economists will be doing. Thus, he writes:

One gets the sense, at least from the outside, that the intellectual energy is no longer with the economists who construct abstract and elaborate models. Instead, the field seems to be moving in a humanist direction. Many economists are now trying to absorb lessons learned by psychologists, neuroscientists and sociologists. They’re producing books with titles like “Animal Spirits,” “The Irrational Economist,” and “Identity Economics,” about subjects such as how social identities shape economic choices.

What sells in the wider audience, however, is not what economists are actually doing. It is a good market response to write a popular book saying economists are stupid, or whatever. But the professional work is getting more technical not less. Despite the impressions of Brooks or Skidelsky economists for the most part do not see the financial crisis as a repudiation of their efforts. So there is no reason to re-evaluate what economists do. I think that is how this is viewed internally. And that is what governs the dynamics of the profession.

Paul Samuelson passes away

Paul Samuelson, the father of modern economics, passed away. Here is the NYTimes obit. Samuelson is clearly the most influential economist of the last century, even including Keynes. While the Keynes may have made a revolution, Samuelson made contributions to so many basic areas of economics that it is hard to enumerate them all. Clearly, he could have won several additional Nobel Prizes if these were given for specific contributions rather than lifetime achievements in the early days.

Nobel Prize

The Nobel Prize in economics will be announced on Monday. Our annual lottery (which tends to be more accurate than all other pools and lotteries in the profession) is underway. Here are the latest odds.

Economist	Payoff to a Dollar Bet
Diamond	5.5	to	1
Mortensen	7.6666667	to	1
Pissarides	7.6666667	to	1
Shiller	12	to	1
Sims	12	to	2
Nordaus	18.5	to	1
Fehr	25	to	1
Hansen	25	to	1
Dreze	38	to	1
Hausman	38	to	1
Hendry	38	to	1
The Field	38	to	1
White	38	to	1
Williamson	38	to	1
Arthur	77	to	1
Barro	77	to	1
Broom, John	77	to	1
Feldstein	77	to	1
Hart	77	to	1
Holmstrom	77	to	1
Jorgensen	77	to	1
Kornai	77	to	1
Krueger	77	to	1
Nelson	77	to	1
Sachs	77	to	1
Sargent	77	to	1
Wilson	77	to	1
Winter	77	to	1

Last Temptation of Risk

Barry Eichengreen has an interesting article on the Last Temptation of Risk over at National Interest Online. The point is to explain how economists did not forecast the crisis. His argument is that the problem was not theory. Rather,

the problem lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking. It discouraged whistle-blowing, not just by risk-management officers in large financial institutions, but also by the economists whose scholarship provided intellectual justification for the financial institutions’ decisions. The consequence was that scholarship that warned of potential disaster was ignored. And the result was global economic calamity on a scale not seen for four generations.

Think of agency theory. This certainly predicts the conflicts of interest between shareholders and management that induced excessive risk taking. And information theory suggests that market prices may have plenty of noise, and that sellers will know more about assets they sell than buyers. The ingredients for understanding the crisis was there. So why were they ignored?

Eichengreen argues that we were seduced. Agreeing with the de-regulatory zeitgeist led to lucrative speaking fees and consulting gigs. The Shillers of the world only prosper after the fact, the facilitators during the boom. Hence, he writes:

What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. In fact, these observations and others had been imaginatively elaborated by contributors to the literatures on agency theory, information economics and behavioral finance. Rather, the problem was a partial and blinkered reading of that literature. The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object. It is in this light that we must understand how it was that the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.

Eichengreen then argues that the increased popularity of empirical economics may help us avoid this problem in the future. I am less convinced by this argument. It is just as easy to cherry pick empirical work as theory. But the major thrust of the article is well worth reading.

Martin Feldstein and the NBER

David Warsh has a nice article on Martin Feldstein and his contributions to the profession at Economic Principals.