How to be a good economist

It has been difficult to resist writing about Dani Rodrik’s new book, Economics Rules: The Rights and Wrongs of the Dismal Science, before the embargo date, but at last I’m free to say how terrific it is. Rodrik is of course one of the most eminent public intellectual economists, engaged with policy and the ‘real world’, and a natural communicator. I’m completely in sympathy with his dual aim of aiming the correct criticisms at economics while defending it others: “I have long been critical of my fellow economists for being narrow minded, taking their models too literally and paying inadequate attention to social processes. But I felt that many of the criticisms coming from outside the field missed the point.” This might sound defensive but it matters to get the criticisms right: some of the old chestnuts (too mathematical, all about selfishness etc) give economists a free pass because they allow them to ignore the more troubling issues.

What are these? Rodrik supports the mathematical nature of economics as bringing clarity of meaning, and argues that the subject is far more applied and empirical than its detractors realise. But he criticises large-scale macro models and time series regressions. “I cannot think of an important economic insight that has come out of such models,” he writes. He also flags up the lack of testability of many economic models: they purport to be deductions from theoretical principles, but as they are ‘deduced’ to explain a particular phenomenon (credit rationing, say), then that phenomenon cannot be used to test the model. “Very few of the models that economists work with have ever been rejected so decisively that the profession discarded them as clearly false.”

Another consequences is that there are huge waves of fashion in economic models. Almost the opposite problem is the use of models that *are* built up from 1st principles and have no relationship with reality – prime culprits being macro DSGE models.

Finally, Rodrik writes, “The profession values smarts over judgment, being interesting over being right – so its fads and fashions do not self-correct.” I would suggest (Rodrik does not note this) that this helps account for the male dominance of economics (like philosophy); young women are very strongly socialised out of this kind of showy intellectual display.

So what, then, does the book argue is good about economics? Rodrik portrays the version of the discipline done well as highly empirical, using inductive and deductive methods, sensitive to context – historical, social, conjunctural – and eclectic in its selection of models. It’s horses for courses. We should think of models as a kind of library of diagnostic texts.

Towards the end of the book, he addresses the kind of challenge exemplified by Michael Sandel’s What Money Can’t Buy: The Moral Limits of Markets. Sandel writes: “Putting a price on the good things in life can corrupt them. That’s because markets don’t only allocate goods, they express and promote certain attitudes toward the goods being exchanged.” Rodrik acknowledges that economists could do with a “richer paradigm” of human behaviour but defends the economic efficiency lens, the analysis of the efficient allocation of resources. Efficiency is a good thing, an important consideration. If carbon trading will reduce emissions, and you believe that to be vital, why would you reject the market approach as immoral? This section ends: “The early philosophers encouraged the spread of markets not for reasons of efficiency or for the expansion of material resources, but because they thought it would produce a more ethical, more harmonious society. It is ironic that, three centuries later, markets have come to be associated in the eyes of many with moral corruption. Just as today’s advocates of markets overlook the limits of efficiency, perhaps the critics neglect some of the ways in which markets contribute to a spirit of co-operation.”

The main message I hope non-economist and economist readers alike will take away from this book is the importance of specific contexts for economic analysis and policy. The book ends with Jean Tirole explaining how frustrating it was for many people, when he won his Nobel Prize, that it was impossible to summarize his work in a brief statement. “It is industry-specific,” Tirole said. “The way you regulate payment cards has nothing to do with the way your regulate intellectual property or railroads.”

The final couple of pages have Rodrik’s Ten Commandments for Economists. Numbers one and two are: Economics is a collection of models; It’s a model, not the model. And also Ten Commandments for Non-Economists, which include: maths is useful; economists are not all alike; economists typically do understand how markets work.

I’m not sure how much traction any book trying to bridge the gap between the best of economics and the subject’s critics can gain (having tried myself in a different way by explaining some areas of economics on the research frontier in The Soulful Science.) The fact that there are plenty of economists doing the version Rodrik criticises in the book doesn’t help our cause; just turn on the TV or read social media and you find oodles of economists making strong, universal claims about macroeconomic policy or trade policy. But I hope open-minded critics of economics will read Economics Rules to learn how the best of economists approach the subject, and how important their work is.

By the way, Dani Rodrik is speaking at the LSE on 7 October.


Machines and humans

A couple of interesting tech-related books have arrived. I’ve started Humans Need Not Apply: A guide to work and wealth in the age of artificial intelligence by Jerry Kaplan & am enjoying it. He is a tech entrepreneur now teaching at Standford’s computer science department. The book starts with a useful overview of the history of AI, which is as far as I’ve got. It’s very engagingly written and is good at bringing the subject to life.

The other is A Prehistory of the Cloud by Tung-Hui Hu, which looks fascinating, a part of the history of the internet that is rather unfamiliar. For example, there’s a chapter on data centers. I’m fascinated by the relationship between the embodied and the disembodied parts of the networks & we know so little about the buildings and wires. There is Tubes: Behind the Scenes at the Internet , which was a good read but disappointed me in terms of hard information. So I’m looking forward to reading this new book. Paging through, it clearly covers social and institutional issues as well as the technology – or in other words the humans too.

Services and the singularity

I just finished an intriguing but eccentric book I’d become aware of in some way following through the thickets of reference in recently-read papers. It’s J.O.Jansson’s 2006 The Economics of Services. Intriguing because there are some interesting insights. Eccentric because he proposes a completely new way of defining services in our mental construction of the economy. I’d love to know what others have made of this book.

The redefinition is to step away from the idea that it is intangibility that’s the defining characteristic of services. He argues that storability and ownership mark the boundary. Intangible digital ‘services’ should be classed as goods because they can be stored in a range of formats. Wholesale and retail distribution should also be classed as the final stage of goods production because ownership of the goods remains with the distributor. Business-to-business services are purely intermediate goods. Services proper are consumer services, non-storable intangible goods with localised markets (although some are sufficiently high value that the geographic dimension is irrelevant). On this basis, Jansson-services account for about 50% (not 70-80%) of the developed economies, and have been at about this level for a century.

So I’m mulling this over. It is surely right to distinguish between different economic characteristics of different services/intangibles. The geographic dimension and its relationship to ‘unit’ value of the service is a welcome addition to the analysis. I also like the introduction of time use, and the time spent consuming a service as part of its cost.

Jansson also highlights, drawing on the fascinating work of Jonathan Gershuny, the margin between personal services affected by the Baumol cost-disease and home production. He argues that as services such as health and education take an ever-greater proportion of income, there will be a switch into consumer capital investment enabling home production – I suppose in a parallel with electronic home music devices and orchestral performances, we might in aggregate spend less on education if Khan Academy or MOOCs offer an alternative.

Coincidentally, this is the 2nd thing I’ve read recently drawing on Baumol – the other was William Nordhaus’s terrific paper Are We Approaching An Economic Singularity? Surely Will Baumol ought to have had a Nobel Prize?

The social context of economic (dis)order

In between ‘work’ books, I polished of this weekend Naples ’44: An Intelligence Officer in the Italian Labyrinth by Norman Lewis. His travel books span the decades from the 50s to 2003, when he died at the age of 95. The biographical note in this reprint of a 1978 book says he was proudest of his work campaigning for the rights of indigenous people in Latin America. All round, he obviously had an astonishingly rich and varied life. I highly recommend this book.

This account of Naples in the immediate aftermath of the Allied landings is an extraordinary evocation of a starving, chaotic lawless city, in which Lewis’s job as a member of the Field Security Service was to create some order. Needless to say, this was impossible. The black market demonstrated its usual vigour and more, given that the Allied Military Government was led by the US, who had selected Italian-Americans – naturally – to run the show in Italy. These men were – naturally – Mafia or Camorra. They and their nominees filled any vacuum left by the collapse of civil society and the departure of the Germans.

This ordered-disorder is quite a contrast to the spontaneous order of the prisoner of war camp economy described by R.A.Radford in his 1945 article. The social relations and cultural norms make all the difference to how economies operate even in two similarly resource-poor contexts.

Not the sharks’ fault

Joris Luyendijk is speaking at the Festival of Economics in Bristol in November so naturally I had to read his book Swimming with Sharks: my journey into the world of the bankers and have torn through it. It’s a fantastic book, and is up there with Whoops! by John Lanchester as a guide to the financial crisis. There is lots of close observation, not unsympathetic. For example, spotting that it’s the Continental European bankers who wear blue suits and brown shoes – so true. What’s that about? His many interviews also provide revealing vignettes, like the group of middle-ranking bankers singing ‘Another One Bites the Dust’ in authumn 2008 when news of another bank failure broke.

It’s also a terrifying book. In the opening pages Luyendijk reminds us how close the economy and consequently society came to collapse in October 2008. In the UK we were a few hours away from cash machines, supermarket and petrol station tills not working, logistic chains breaking down. The Bank of England Court minutes recently published confirmed demand for cash had shot up and new banknotes had to be printed. I certainly got out a lot of cash. By the end of Sharks, you realise that the whole thing can happen again, and probably will. Nothing has changed.

This is not because bankers are immoral and greedy, although many, he says, are amoral. It is a whole system problem: the gripping image is a plane, on which we’re all sitting having a meal and a drink, slowly realising that the cockpit is empty. Interestingly, he pinpoints a specific London problem of people staying with high-paying City jobs because they have a huge mortgage and high school fees.

Like Luyendijk, I’ve often wondered why there has been so little political imperative to change the system – it is a matter of politics. And some of the key measures are not at all difficult to get your head round: smaller banks, and much, much more equity capital and less leverage. Simples.┬áIt’s a good time for new books about finance, with John Kay’s Other People’s Money and Adair Turner’s Between Debt and the Devil. Let’s hope that a new crop of books making exactly the same recommendations will help change the political climate. That means lots of people need to read them – and of course come the the Festival of Economics.