Why was economics so insular?

Noah Smith has a good piece on what seems like the never ending stream of popular articles in the UK slagging off economics (or economists). Here I outlined three potential reasons for this epidemic: people do not understand unconditional macro forecasts, politicians from the right do not like economists spoiling their pet schemes (e.g. Brexit), and many heterodox economists from the left wage endless war against the mainstream. All these complaints get airtime when the economy is bad.

The UK economy, right now, is perhaps in a worse state than at any time in the last eighty years. As John Lewis shows in this Bank blog, productivity growth has perhaps never been as bad as it is now: we have to go back to before 1800 to find anything comparable.

The natural reaction when the economy is bad is to criticise economists. That was what happened after the Global Financial Crisis, with some justification. But what is happening in the UK right now is mainly a result of first austerity and then Brexit. As I explained in detail in my earlier post, if we had followed the advice of mainstream economics austerity and Brexit would not have happened. [1] I have as yet not read a single critique of economics that has pointed that fact out, which if you think about it is extraordinary.

There is a little more to say about why economics is an easy target. Historically it has been very insular, and in this respect quite unlike other social sciences. I have already discussed the paper by Haldane and Turrell in the OXREP Rebuilding Macroeconomic Theory volume on Agent Based Models, but I did not have space to show an interesting chart from the introduction to that paper.

It tracks citations in papers to those in other disciplines. Until around 2000, there was no doubt which was the most insular discipline: economics. This is no surprise to me and I suspect most social scientists.

The paper does not explore the reasons why economics is so self-referential: their aim is simply to suggest that it needs to look to other disciplines to see what methods they use. Here I want to sketch why I think mainstream economics (and here the qualification mainstream is required) is so insular.

I once gave a lecture course on the methodology of economics, and in one lecture I used a large blackboard to describe how nearly all economics can be derived from the basic axioms of rational choice. For example the modern macroeconomics of consumption is just the choice between buying apples or pears transformed to the choice between consumption at different times. In that sense economic theory is like an immense tree, where every branch deductively builds on this core. Sometimes large branches grow by adding new elements, like asymmetric information, which then becomes part of the tree and can be used by other branches. This deductive tree of economic theory did not grow all by itself: its growth was and is influenced by the real world problems it wanted to address.

In using the idea of explaining decisions by optimising welfare under constraints economists have created a whole series of widely applicable tools. Economists naturally think about opportunity costs, adverse selection, moral hazard, incentives etc. There is something distinctive about thinking like an economist. To say, as Tom Clark does here, that sometimes this is just formalising common knowledge may be true (see also Cahal Moran here), but in many cases it is not. Try persuading someone who has invested in what is now a sub-optimal project about sunk costs.

This body of theory includes the neoclassical economics that heterodox economists and others love to hate, but it also includes game theory that has applications well beyond economics, and more. In my first year of studying economics I was told in some lectures that this whole endeavour was a huge ideologically driven misstep, but I began to see it differently after reading this famous 1963 paper by Arrow. It shows why (asymmetric) uncertainty in the health service means that the standard competitive model just cannot work for medical care. That may be obvious to us in the UK but it appears otherwise to many in the US. To be fair Clark also acknowledges that this economic theory has produced positive successes: he mentions auction theory but there are many more.

As to ideology, if you want an effective critique of neoliberalism you have to use economics (see, for example Colin Crouch’s book on neoliberalism or this by Dani Rodrik). So many critiques of economics use a kind of bastardised version that insists that workers are always paid their marginal products that the political right also employs. But monopoly and monopsony power are also part of the deductive tree. A paper I like to refer to in this context is by Piketty, Saez and Stantcheva (discussed here) which uses a simple bargaining model to show how cutting the top rate of tax can increase pre-tax CEO pay.

There is nothing like this deductive tree in other social sciences, and I think it at least partly explains why economics used to be so insular. As non-economists academics seemed to add little to building on this theory, there seemed little point in collaborating or even citing them. But, from the point of view of other disciplines, it was worse than that. Economics could also be imperialistic. Its methods, both theoretical and empirical, could be applied to other fields (with varying degrees of success): here is David Hendry applying his econometric methods to climate change, for example. So not only did economists not talk much to other social sciences, they trod on toes as well.

But although there may still be important branches to be added [2], the limitations of what you can do with a few axioms about rational choice have led in recent years to economics becoming much more empirical, and much less tied to this deductive theory. (See the article by Noah Smith which began this post. Unfortunately in my view an exception to this trend so far is macroeconomics.). We can see this in the citations data above, and the most obvious manifestation is behavioural economics. But a more immediate example of a data rather than theory based idea is the gravity model in international trade, which lies at the heart of why Brexit is such a bad idea. It is irony indeed that just at the point at which we have all these articles attacking economics, a large number of people who believe the UK is committing a large act of self harm are seeing the virtue of just one small part of what economists do.

Having said all this, I think there is an unfortunate hangover from this insularity. As a discipline economics shows little interest in communicating its core knowledge to others [3]. This can be true both within academia and with the outside world. Within academia publishing in top economics journals still has far higher status than top journals in other disciplines. When it comes to policy and the public, there is a belief among many that when either requires our wisdom, they will seek out the best of us for advice. In part this epidemic of articles about the failings of economics reflects this communication failure. More importantly, both Brexit and Trump should be a wake up call that economists as a collective has to get better at communicating the core insights of economics.

[1] There are of course more underlying problems behind the UK productivity crisis beyond the negative shocks of austerity and Brexit. But economists overwhelmingly argue for more R&D spending and more public investment. In short if you want someone to blame for why the UK economy is currently in such a dire state, blame those who have ignored the advice of economists.

[2] Most of the good criticisms that I see of economics amount to requests to add to the tree. But economics is so rich that most things are possible. In part (but only in part) what is done follows the money: you will find it relatively easy to get money for work on free trade compared to work on rent seeking. To blame economists for that is just bad economics. As economists found out after the financial crisis, they had many tools to understand what had happened, but had just not applied them before the crisis.   

[3] I say as a discipline because I mean economists as a collective, not as individuals. There is no equivalent institutional infrastructure in economics to that built by the hard sciences. Of course many individual economists do their best, but there are also others who ignore the consensus to plug their own personal ideas or to further some political or ideological cause.

Why does economics get so much stick?

Because the advice of economists is so hopeless, you may say. Well think about the following thought experiment. After the financial crisis. suppose people had done the opposite of what the majority of economists said they should do. We do not need to imagine over Brexit, because most of the 52% who voted for Brexit chose to ignore, or more likely did not hear, the advice of 90+% of economists that Brexit would make them worse off. For those who work that belief was quickly shattered as their real wages fell as a direct result of Brexit.

Immediately after the financial crisis interest rates would not have been cut and austerity would have started in 2009, not 2010. Banks would have gone bust because economists said we needed to bail them out. In which case the Great Recession would have become the second Great Depression. Because the majority of economists did not support austerity you would have had continuing cuts in spending during this new depression.

So comparing this thought experiment with reality, we can see that economists have prevented a rerun of the 1930s depression, and if their majority advice had been taken we would have had a stronger recovery and the UK would not have left the EU. Sounds pretty good to me. But, as I’m sure you are now saying, what about the financial crisis the economists failed to warn of?

That was a mistake, but what are the consequences? Do you really think that if most economists had warned about how fragile the sector was anything would have happened? Banks would have continued to lend because they were making money and they had a guaranteed bail out from the state. Their campaign contributions would have weighed far more heavily in politicians’ minds than warnings from economists. So yes, not warning about the financial crisis was a mistake, but it would not have changed anything if the mistake had not happened. Economists are often told to stop being naive about politics, but the same needs to be said to their critics.

Despite such a strong record in macroeconomics since the crisis, why does economics get so much stick? I think there are three reasons. The first is simple: when the economy goes wrong, economists are easy to blame, particularly because of those forecasts that never predict downturns. In reality virtually no academic macroeconomists are involved in forecasting because they know that kind of unconditional forecasting is a mugs game [1], and furthermore most economists are not macroeconomists, but for some that kind of detail is irrelevant. (There are also plenty of highly successful pieces of microeconomics, but most critics act as if economics was just macroeconomics.)

The second reason is politics. Carlyle in 1849 called economics the dismal science because economists did not support his idea of reintroducing slavery. Ever since then economics has annoyed politicians and their supporters of various colours by pointing out the problems with various political programmes or schemes.

Politics is also at the heart of the third reason for criticism: politicians and ideologies of the right use the aspects of economics that suits their cause. Want to promote markets? Just take the idea from economics that an ideal market is an optimal way of exchanging goods, and ignore all the ways that real markets deviate from this ideal (ways which, incidentally, a great many economists spend a lot of their time studying). Some heterodox economists of the left, rather than use mainstream economics to point out how the right plays fast and loose with economic ideas, prefer to suggest that mainstream economics is much closer to the right wing caricature than it is in reality. It is why, as Noah Smith observes, so much of this criticism can be found in the pages of the Guardian.

This misrepresentation of mainstream economics is either deliberate or reflects ignorance. Ignorance about the fact that a lot of economics has become more empirical and therefore more eclectic in its use of theory over the last few decades, perhaps in part because of the influence of behavioural economics. Ignorance that even in macroeconomics, where ideological influences can be strong, there is more consensus around New Keynesian economics than some mainstream Keynesian economists imagine. (See my survey with André Moreira of post graduate teaching at the top schools here.) Nowadays you will find that in most areas of economics (alas not yet macro so much) there is nothing limiting the analysis to selfish individualistic behaviour. The idea that economics is like a religion is absurd.

But sometimes it is hard not to believe that popular criticisms of economics choose to ignore how far economics deviates from the neoliberal characterture. There is no excuse for ignoring that, for example, the best arguments against health care being left to the market can be found in a paper by Nobel prize winning economist Kenneth Arrow written decades ago. As the recent book by Colin Crouch suggests, the best critiques of neoliberalism come from within economics.

Another ridiculous charge against economics is that economics has a natural bias against state intervention. Indeed it is possible to argue the opposite. In my own field it is typical to assume the existence of a benevolent policy maker, who maximises social welfare. It is essentially just a useful analytical device, but you could argue if you wished to that this device biases those that use it to favour state intervention.

Judging by recent conversations I have had, many heterodox economists attack the mainstream because it uses the distinction between positive (value free) and normative economics. An example of positive economics would be me saying a temporary cut in government spending when interest rates are stuck at their lower bound reduces output. A normative statement would be that austerity is unfair. Heterodox economists like Sheila Dow seem to suggest that everything is value laden, and the positive/normative distinction allows economists to avoid being “morally implicated in the advice they give.”

I think this criticism is either trivial (yes, of course there may be normative reasons for choosing particular research topics) or dangerous. It is dangerous if it suggests that economists should be encouraged to base their analysis on assumptions that reflect their values. Economics, even though it is a social science, should conform to the scientific method: it should be as much like a science as medicine. Indeed I think it would greatly improve the public debate if both economists and their critics realised that economics, even though it is a unique and inexact science, is more like medicine than any of the hard sciences.

Dow writes “Getting policy-makers or the general public onside over a particular argument is therefore, critically, a matter of persuasion rather than demonstrable proof (since that proof is impossible).” But surely the best way of trying to persuade a policymaker not to impose austerity is to say that most models, including the consensus theoretical model, and nearly all the evidence suggests austerity will reduce output. In contrast it is far too easy to persuade a politician of things they want to hear. We do not want politicians to pick advice only if it is given by ‘one of us’ (by those who share their values), or as a result of the rhetorical skills of the academic.

The danger in encouraging plurality is that you make it much easier for politicians to select the advice they like, because there is almost certain to be a school of thought that gives the ‘right’ answers from the politicians point of view. The point is obvious once you make the comparison to medicine. Don’t like the idea of vaccination? Pick an expert from the anti-vaccination medical school. The lesson of the last seven years, in the UK in particular, is that we want mainstream economists to have more influence on politicians and the public, and not to dilute this influence through a plurality of schools of thought.

All this does not mean that economists are beyond criticism. As my last post pointed out, I have fundamental criticisms about current macroeconomic methodology. An important point to note about the microfoundations methodology is that it excludes economists who are not prepared to sign up to what is currently considered (by macroeconomists) acceptable microeconomics, or who do not think microfoundations is where you have to start in doing macro. But this critique has nothing to do with values. The mistake macroeconomics made in the 1980s was not in their desire to look for microfoundations, but in deciding that models that had internally consistent microfoundations were the only admissible models.

The big problem with most criticisms of economics you see in the media is not that economics is beyond criticism: as the paragraph above suggests it in many cases should be criticised, and there are plenty more interesting criticisms of economics available. The problem is that these more important criticisms are not those you find in the pages of the Guardian. The typical criticisms you see in the press are just not very good, and I fear reflect either ignorance or ideological antipathy.

[1] A lot of the criticisms of forecasters are themselves spurious. Someone who writes “economists should not need to pretend that we can predict things that do not really matter to several decimal places” are themselves pretending that there are any serious forecasters who do pretend this.