Where did economics go wrong

David Colander and Craig Freedman have an answer. ‘Where Economics Went Wrong‘, to give the title of their new book, is answered by the subtitle: ‘Chicago’s Abandonment of Classical Liberalism’. They have something very specific in mind by this, namely the move from widespread acceptance by economists that economic policy does not follow from economic theory, but rather is “a blend of engineering and judgement”, an art rather than a scientific endeavour. They continue: “Clearly one wants evidence-based, objective analysis of policy. An art and craft methodology uses theory and science whenever it can.” But policy is messy and requires a methodology recognising the unavoidable role of normative judgments.” This is what they mean by classical liberalism.

The Chicago School upended this, the book continues, by “removing the firewall between economic science and policy” from the 1930s on. It did so to further a laissez faire agenda, insisting that economic science justified the conclusion in real life policy that the market should be left to its own devices. It merged economic theory and science with economic policy advice. This agenda held sway for some decades, embedded in policy by politics and the electoral success of Reagan and Thatcher.

I must say I found this argument confusing  at first because of my own perspective that the problem for much of 20th century economics was the ‘separation protocol‘ between positive analysis and normative advice, expressed by Lionel Robbins and later by Milton Friedman. However, I think it’s a similar point in fact: the claim they made was that positive economic analysis was appropriate for policy, and value judgments could be coralled into the domain of political choice, about which economics has nothing to say.

Many economists probably still think this, but my sense is their number is diminishing. Colander and Freedman end the book with an overview of the work of six economists they perceive to be working in the ‘art and craft’ policy tradition: Dani Rodrik, Ed Leamer, Amartya Sen, Ariel Rubinstein (love his book Economic Fables), Alvin Roth, Paul Romer. A shame they’re all men but I for one approve of the selection, with that major caveat.

The book is an inside-the-beltway one, of interest mainly to history of thought folks I would guess. Having said that, it does highlight a key methodological issue of importance to all applied economists.

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Lionel Robbins on economics

I just re-read the famous Lionel Robbins Essay on the Nature and Significance of Economic Science. Every time one reads a book, it’s with new preoccupations and interests. So this time, here’s what jumped out at me:

“Value is a relationship, not a measurment. … It follows that the addition of prices or incomes to form social aggregates is an operation with a very limited meaning.”

“The idea of precise ‘correction’ of price changes over time is illusory.”

For Robbins, economics is essentially price theory. He wrote the essay of course in 1932, just before the development and subsequent rise to prominence of aggregate economic measures and price indices. But I think he was right to underline the pervasiveness of relative price changes and the consequences for aggregation.

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Rhetoric and reality in economics

There are plenty of ill-informed criticisms of economics, alongside the very valid criticisms of the subject. It’s frustrating if one wants to see the discipline move in desirable directions – a higher proportion of women and people who aren’t white & middle class, less ‘boys’ toys’ abstraction, more open (again) to history, sociology and other related subjects, etc – because responding to ill-founded critiques is such a waste of time. Yet the false myths need busting if real reform is to take place.

A recent article by Larry Elliott in the Guardian was outstandingly ill-informed. So much so that it prompted some of the UK’s most esteemed economists to write an excellent reply in Prospect. Their most important single point is, perhaps, that the econ-bashers are feeding the dangerous current in politics of disparaging expertise. We economists need to be duly modest about what we know, but we certainly know more than, say, some current members of the Cabinet.

I tweeted the link to the Prospect article, which led someone to come back on Twitter with this.

NelsonSmythe
@DianeCoyle1859 @prospect_uk Gonna throw a bit of Deidre McCloskey’s ‘Rhetoric of Economics’ in here: https://t.co/vyGzJiHRjx
21/12/2017 08:42

Here is the McCloskey quotation:

rhetSo I turned to my copy of McCloskey’s 1985 Rhetoric of Economics and particularly the postscript to the 1998 edition. There she is at some pains to correct readers of the 1st edition who’d concluded she is ‘against’ mathematics in economics, saying: “A lot of good work gets done in economics, new facts and new ideas. Economists are not stupid or lazy, not at all. I love the field. I belong to the mainstream.” Her target is what she describes as the ‘sandbox for boys’ games’ – ultra-mathematical and abstract – far from a wholesale criticism of maths in econ. Famously, she also condemns the unthinking worship of statistical significance – and indeed any economist worth their salt will also be absorbing the recent papers by Alwyn Young and by Ioannides et al in the Economic Journal.

Still, one can’t plonk The Rhetoric of Economics (remember, pub. 1985) down as a killer retort to the economists’ demolition of the latest dangerously misleading attack. As the Prospect economists note:

The way economics is done has been transformed in the past 30 years with an empirical revolution, meaning we now use fine-grained data on individuals, households and firms. In a recent survey of published work in top journals, over three quarters of papers analysed data collected either by the researchers themselves or from secondary sources. Economists provide evidence, increasingly using randomised control trials, or big data. Often this leads to theories being supported or knocked down: this is the bread and butter of modern economics.

My 2007 book The Soulful Science described a lot of the change since the 1980s this refers to. Perhaps it’s too much to hope for, but I do wish people who condemn economics would actually pay more attention to #whateconomistsreallydo

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No Ordinary Woman

I’ve really enjoyed reading No Ordinary Woman, a biography of Edith Penrose by her daughter-in-law Angela Penrose. It is a life story kind of biography – only one chapter (by Edith’s grandson Jago) covers her economic thinking in The Theory of the Growth of the Firm – but what a life.

There’s no question in my mind that, had she been a man, Penrose would be far more esteemed within the economics profession. I haven’t read The Theory of the Growth of the Firm (shame on me – got it out of the library now), and it seems it has been far more influential in management and business schools than in economics. It seems, from the chapter here, that it explores the firm as an institution, and the dynamics of the way firms shape the economic environment.  One can see how this is more at home in the business literature, valid (in fact, essential) as this kind investigation is.

But whatever its stature, Penrose had an extraordinary career as an empirical economist helping shape the field of study of multinational firms, an academic leader (head of the economics deparment at SOAS as it built its reputation, and later at INSEAD), and a public servant (serving on many public bodies and commissions after she and her husband settled in the UK). At the time the OPEC crisis erupted, she was just about the only academic who had studied the oil industry and the Middle East economies. She travelled widely, learnt Arabic and did some consultancy work in her spare time – and all this while bringing up her family and being a housewife to her husband, much-loved but clearly a traditional man of his era.

Anyway, from this affectionate biography, Penrose sounds like she would have been terrific fun and stimulating to know. And it is inspiring to read about a woman who accomplished so much against great odds. Next week in Manchester we’re hosting an event for 14-15 year old school girls to encourage them to do economics in the 6th form. Edith Penrose has to join the pantheon of female economists we’ve been preparing.

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Economics for good

Jean Tirole’s book Economics for the Common Good is out now and is highly recommended. As I had the privilege of helping prepare the English edition, I’ve read it with careful attention, and most appreciated Tirole’s ability to crystallise complicated issues in a straightforward way, combining surgical analysis with very clear explanation. This is too rare a skill among economists.

The first part of the book concerns the influence of economics and economists on society and the role of the market, followed by a section on what doing (good) economics involves, and also how economics is changing. There are then two chapters on organisation, the first on the relationship between state and market, the second on the role of business. These sections are in the same spirit as Dani Rodrik’s Economics Rules, although their experiences and examples differ. Here in Economics for the Common Good is an economist at the pinnacle of the profession (Tirole won the 2014 Nobel prize) giving a thoughtful, reflective account of what economics can properly contribute to – well, the common good. Although much of his work is highly technical, he has always been concerned with its application to practical challenges in organising society: “Academics must ..collectively aim to make the world a better place; consequently, they cannot refuse, as a matter of principle, to take some interest in public affairs.” If an economist has appropriate professional competence in some area, she has an obligation to take a position on it – while acknowledging that what is known changes and re-evaluation may always be necessary.

The final two sections of the book turn to applications of economics, big macroeconomic questions such as financial market stability or tackling climate change, and then applied microeconomic issues such as competition policy, digital platforms, intellectual property and the regulation of network industries. Given my own interests, this final section was riveting. No other individual economist has done more than Tirole to take forward the economic analysis of these kinds of areas, incorporating issues of asymmetric information, principal-agent problems, incentive compatibility, and so on. The final chapter, on sector regulation, is a must-read for anyone interested in this area. (I drew on it in a recent FT column.)

The book is non-technical, aimed at the general reader, and packed with examples. It does in parts require a careful read, but each sections and chapters stands being read alone, so one can dip into the book. There’s a nice publisher blog post in which Tirole explains his motivation for writing the book and what he hopes it can achieve.

It ends with an epilogue reflecting on the status of technical knowledge in a time of populism (the French edition was published early enoug in 2016 that it feels like a different era), and the even greater responsibility economists have to engage and communicate – “Economists must … with humility and conviction, harness economics for the common good.”

Price: £17.65
Was: £24.00
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