Economic History and Krugman’s Crib Sheet

One of the positive things about reading blogs is that sometimes you see connections in apparently diverse offerings. So here are two seemingly unconnected posts: Paul Krugman’s discussion of how he came to do his path breaking research in international trade and economic geography, and Kevin O’Rourke’s post on why economics needs economic history.

I remember many years ago being in a large interdisciplinary forum, where Krugman’s research on economic geography came up. The economists in the room were of course very positive, but the geographer there could not hide his disdain. There is nothing in this work that geographers have not actively discussed for the past 50 years, he said. I have no reason to doubt that he was right, but it kind of missed the point. What Krugman and others did was manage to formalise these earlier thoughts in a particularly tractable and useful way.

What is so great about formalism, you might ask. The trouble with just talking and writing about the way the world works is that it is quite easy to become confused or to make mistakes. Macro, because it deals with a highly interconnected system, is full of these pitfalls. The example I use with undergrads when they first come to IS/LM is as follows. Cutting taxes may appear to boost the economy, but if it is financed by more government borrowing, to persuade people to lend more will probably push up interest rates. These higher interest rates reduce output, so as a result tax cuts could end up reducing output. Sounds reasonable, but the reasoning is incorrect. The worst that can happen with a tax cut is that people save it all, in which case output does not change, and neither do interest rates. IS/LM shows us that if interest rates rise it is because output has increased.

So it is good to be able to express ideas about how the world works in terms of simple models. But creating a new type of model for the first time is not an easy thing to do, which is why you get prizes for this kind of thing. Crucially, it may take a long time (decades or more) before someone comes up with that nice simple formalisation that captures those ideas. Yet those ideas are as important before the formalisation as they are afterwards - it is just the reasoning about them that has improved.

How is economics generally taught? In both macro and micro, most of the time we teach the formalisation. This is understandable (it is what has advanced the discipline and made it science like) and to a degree appropriate (understanding models is difficult). However there is a real danger that teaching this stuff crowds out all else. I used not to be concerned about this for macro, because I saw the discipline as inherently progressive, where the data would naturally push advances in the right direction. (My excuse for believing this in part comes from my background in building structural econometric models, where the data really did do that.)

If that is your view, you are likely to be a little dismissive about things like economic history, economic methodology or the history of economic thought. After all, most scientists do not worry too much about these things in their own discipline, and economics tries to be like a science. Even if we take a more realistic view, and think that economists are more like doctors (who fail to understand quite a lot), doctors do not spend too much time thinking about things like the methodology of medicine.

I changed my view in the last few years as a result of both the financial crisis and the subsequent domination of austerity policies. Teaching just what can be currently formalised in what now passes as a rigorous manner excludes too much of what is important. Of course we (hopefully) tell students that there are gaps in what economists can do this way, but perhaps these gaps need to be given a little more space than footnotes. There is a great deal of knowledge and insight in less formal economic reasoning, insight that can too easily be dismissed. Unfortunately it is natural for future academics or policy makers to believe that what is taught in undergraduate or graduate macro is what is important, rather than what has so far been formalised, or what the demands of this particular time and context require formalising, or worse still what political or ideological forces wish to formalise.

The analogy with doctors breaks down because, unlike doctors, an economist does not constantly have the full range of empirical problems thrown in their face. They are also unlikely to have politicians picking and choosing which treatments they like to promote based on the interests of those they serve. In particular, developments in macro over the last few decades have shielded economists from having to explain much of the data. (In my view the dismissal of single equation time series work as a vital component in model building because of identification problems was a crucial mistake.)

As Kevin O’Rourke eloquently argues, teaching economic history provides a useful counterweight to these tendencies. We also need to make room for teaching some elements of methodology and the history of thought, for similar reasons. This is why I have actively supported Diane Coyle’s initiative in the UK (see here, here and here). I think having the occasional option in these subjects misses the point. It is much more about integrating these elements into core courses, although how best to do this remains an open question.