A recent article in Business Line titled ‘Economics or a Blind Man’s Buff?’ http://www.blonnet.com/2009/11/09/stories/2009110950310900.htm lashes out at the inability of economists to predict impending crises. The column quotes work which points out the failure of economists to stay put with reality due to their excessive dependence on complex equations and formulae. However, a closer analysis might suggest otherwise.
To judge economists by evaluating them on the single parameter of prediction is unjustified, as the scope of economics is much wider. Specifically, on the current economic crisis, Paul Krugman had pointed out way back in May 2005 – ‘If housing prices actually started falling, we'd be looking at [an economy pushed] right back into recession. That's why it's so ominous to see signs that America's housing market…. is approaching the final, feverish stages of a speculative bubble." Apart from Krugman many others too saw economic storm signals.
Economists seldom rule the political systems and whatever may be the accuracy in prediction, a strong bureaucracy and a system tempted by greed would inevitably bury the voice of an economist. Prediction is always difficult because crises, no matter how foreseeable, eventually unfold after a trigger event which acts as a tipping point. For instance, the present crisis became a full blown affair after the demise of Lehman Brothers. The assessment that economists have failed in the face of crises also ignores the fact that on numerous occasions, policies suggested by economists have helped avert a potential crisis. This is reminiscent of a problem in statistics called 'sample selection bias'. While assessing economists on their ability to predict crises, our sample consists of only those events where predictions have failed. Since potential crises which were averted are unobservable, they fail to show in the sample space, thereby inducing a bias.
Coming to the age old debate about the relevance of complex equations and formulae, it is important to realize that it is with the help of such methods that simple intuitions are derived. Such methods are necessary when the subject of study does not easily lend itself to abstraction. Contrary to claims that economics has lost touch with reality, Krugman's ‘Two Cheers for Formalism’, points out - “what do we learn about the values of the profession - the sorts of work that command the highest rewards - by looking at, say, the last ten Clark Medalists? Here is the list: 1979, A. Michael Spence; 1981, Joseph Stiglitz; 1983, James Heckman; 1985, Jerry Hausman; 1987, Sanford Grossman; 1989, David Kreps; 1991, yours truly; 1993, Lawrence Summers; 1995, David Card; 1997, Kevin Murphy. In short: two middlebrow theorists whose work on imperfect markets has had major impact both on policy and on corporate strategy; two econometricians whose techniques are widely used in practical applications; two theorists who specialized on issues of information and uncertainty; a trade theorist who focused on increasing returns and imperfect competition; a macroeconomist with a strong empirical and policy bent; and two very empirically-oriented labor economists." Clearly, economics is a subject with wide public outreach and policy impact.
To conclude, we should lay emphasis on the greatest strength of economics – in explaining how societies and individuals behave. During the Great Depression of the 1930s, when economics as a discipline was relatively newer, the government responded to the crisis by following the doctrine of balanced budget, which worsened the crisis. In contrast, the expansionary fiscal and monetary policy undertaken to combat the present crisis has avoided what might have been a crisis of an even bigger magnitude. Economic principles help in explaining how events unfold and guide us to better crisis management. Evaluating the subject solely on the criterion of its predictive accuracy is a great injustice to the discipline. Still, popular economic reporting could help rectify the situation if it brought out more from research into their columns.
2 comments:
I agree. Nicely Done!!!
Many of the recent crises have been the result of acute asymmetry of information. What can an economist do if someone else (Investment Banks/Rating Agencies) commits outright fraud or when correct information is not available?
The cogency of the economist’s trade rests heavily on correct information being available. All deductions are based on information that is available. There is no reason for things to go wrong if the information available is correct. Thus, holding the economist responsible for dupery committed by others is not right.
Very nicely written. I think the single biggest feat of economics in the past century has been the part success of central bankers in infulencing economic activity through the use of monetray and fiscal policy, as was so evidently in display in response to the present crisis. However, as the prolonged Japanese recession post 1990 would suggest, we still have some distance to go in terms of calibrating economic activity. A feat left for the next century to unravel. :-)
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