Tuesday, June 22, 2010

The fall of economics

My colleague Noric Dilanchian kindly sent me link to a post by Troy Henderson, It's The Economists, Stupid, in newmatilda. The post begins:

They may have seemed far from the action, but economics academics are very much to blame for the GFC, and for the other economic crises to come, writes Troy Henderson.

Troy writes from a particular perspective, one that I do not necessarily share, although I would agree with a number of his subtexts, including the dominance of neo-classical economics, as well as the role of values.

In a comment on the post, Syd Walker quoted Keynes:

"the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”

Walker suggests that Keynes' comment was truer then than today, because "today we are dealing with the increasing commercialisation / intellectual prostitution of academia and ‘expert opinion’. "Along with TV", Walker suggests, "we now have a professional punditocracy that is substantially funded by powerful and well organized vested interests. It is able to gatekeep who participates - and who does not - in public discourse, such as economic debate."

I have quoted Syd's comment at length because both he and Troy argue that economic's problem lies in part in the way it excludes alternative views.

My problem with modern economics is a little different. I don't know what it is any more. I am simply confused.

In a sense, I grew up with economics. My father was an academic economist, head of Department and then Professor of Economics at New England. His major interests were development economics and the history of economic thought.

The world of academe was much smaller then. As a child and then a student, I guess that I knew or knew of most Australian University economists. Then I worked as a Government economist for many years, before moving into the private sector as a consultant.

As a student, I saw economics in a number of different ways. It was first the study of economic activity and of the human institutions affecting that activity. In that sense it was part of what we now call the humanities, concerned with one slice of human life. Resources were limited, so economics was also the study of the application of scarce means to alternative ends.

Economics was both a theoretical and applied subject. It's application in policy or in particular fields such as agricultural economics was intended to guide decision making, as well as increasing understanding of what actually happened, the way things worked. Economics dealt with the now and the future. However, Economic History, a core part of the discipline, applied economics' techniques to enhance our understanding of past and present.

Economics was not value free. However, a clear distinction was made between the various theories, applications and constructs and their practical application. Policy advice, for example, inevitably involved values, not just in the way it was phrased, but also in the outcomes.

All honours students were required to do a full year history of economic thought course tracing the evolution of economic thinking. You cannot study something like the evolution of the concept of profit or interest (usury), without seeing the way that  human thinking defines central concepts.

Models were central to economics because complexity required abstraction and simplification. However, they were just that, models. Even then, there was something of a disconnect between the need to learn specific models (theories) so that you understood them and could be examined on them and real world activities.

The theory of the firm was an example. To my mind, there was a disconnect between the idea of profit maximisation and the way firms actually operated. However, the course did include alternative views, with the suggestion (for example) that firms did act to maximise profits, but in the longer term.  

Above all else, economics was a way of thinking, of analysing activities and problems in a rigorous way. I chose to do history rather than economics honours, with a final focus on prehistory. However, unable to escape my past, my honours thesis on the economic structure of traditional Aboriginal life in Northern NSW consciously applied economics thinking to Aboriginal life.

At the time there was a debate in anthropology between Karl Polanyi who argued that economics was only relevant to money using societies (really a models approach) and Cyril Belshaw who argued that economics concepts and thinking could be applied. I chose to follow my cousin and consciously attempted to apply economics concepts to traditional Aboriginal life.

This proved quite fruitful, if also a little artificial. The idea of capital formation, investment of time and resources now for future returns, led me to focus on  Aboriginal investment activities such as fish traps or standing nets. At the time, this aspect of Aboriginal life was ignored because it was largely seen as irrelevant to a nomadic hunter-gatherer society.

In similar vein, I focused on trade and ceremonial exchange cycles. Just because no "money" was involved, just because value in the mind of the receiver included ceremonial and religious aspects as compared to straight use value, did not invalidate the approach. If you want to take a modern example, consider the value of the brand!

After beginning work as a policy economist, I found all this very useful. I did further economics studies at postgraduate level, including econometrics. However, all this fitted into my perception of economics. Then, the wheels started to come off so far as economics as a discipline was concerned.

The dividing point in my mind came in the second half of the seventies. Roger Kilham (a Treasury colleague and friend) and I had been trying to reform the Treasury approach to recruitment. Treasury aimed to recruit good honours graduates, but was finding it harder. A new approach was required.

As part of our work, I rang every university economics department just to check on expected honours numbers. Pretty basic, I know, but if you are trying to recruit honours graduates, then you need to know just what your pool is. I found that the numbers in honours classes had collapsed to the point that the numbers that Treasury needed were no longer there. Part of our recommendations were that Treasury needed to broaden its recruitment approach.

I later found that honours numbers in all disciplines had declined, that while the decline in economics had its own features, it was part of a broader social trend. However, at the time it crystallised some things that I had been thinking about.

I saw economics as a way of thinking. I had also come back to economics after a very heavy dose of history. As a manager who depended on graduate recruits, I was also concerned at what appeared to be a decline in quality. That was part of the reason why Roger and I had begun our attempts to reform Treasury recruitment in the first place.

As I saw it then, a number of factors had combined to threaten the relevance and appeal of economics. I think that they are still relevant today.

The first was the rise of mathematics and model based approaches.

I remember in the mid seventies at a lunch in Canberra, Professor Eric Russell from Adelaide (Eric died of a heart attack in 1977) remarked to my father that universities were now training bad mathematicians and worse economists! There was some truth in that. The point was that the more time you spent on technique, the more you embedded things like maths, the less time there was for broader thought.

The focus on maths and model based approaches affected not just the content of courses, but also the journals (I stopped reading them around this time because I wasn't interested and they lacked relevance from my viewpoint) and economics' ability to attract students.

This was the time that political economy emerged as Sydney as a part response. Speaking personally and as a then recruiter, the problem with Sydney political economy was that it lacked rigour, was too ideological. The idea of a broader course was good, but vanished in the fights that followed.

The second factor was the emergence of combined courses and multiple course options. The practical effect of this was to water down economics content. I remember, for example, interviewing students who had done economics streams as part of broader courses such as international relations or business. They were pretty useless so far as economics was concerned, unable to hold an argument or to critically examine assumptions and issues.

The final factor was the growing dominance of finance and business. I was greatly interested in the emergence of new approaches in areas like corporate finance, but I did not really see this as economics.

When, in the late eighties, I was involved in the marketing of new financial products, we were completely dependant on the mathematicians to do the complex modelling involved. As an economist, I could define structures and relationships, test and critique ideas, but the actual modelling required high level mathematical skills.

This is an area where I part company with the suggestion that economists were to blame for the GFC and will be to blame for the crises to come. You see, I don't really see the complex market models as economics at all, rather as subsets of mathematics and corporate finance. Where economists failed as economists was in their inability to detect the risks involved.

In all this change, the first thing that really stands out is the decline of economics as a discipline. Just to illustrate with a personal example, in the public policy work I have done over the last few years I have seen very few economists even in areas where I would have expected them.

This is actually a huge problem from my perspective. The language and analytical techniques that I apply based on my studies and years of experience fall outside current bounds. I look at something and can say quickly that it probably won't work, point to things that need to be considered. Then I have to try to explain from first principles.

In one case I was dealing with, a sector restructuring exercise, there was not a single person involved at any level who had economics. Even the idea of looking at the sector as an industry, of asking basic questions about structure, conduct and performance, was alien. Of course those involved actually had to address these issues, but they lacked the framework to do so. I was left with the feeling that the concept of a broad based generalist economist was dead.

The second thing that stands out is the way the changes in economics interface with broader trends that I have tried to delineate over the last few years. For example, the rise of econometrics, the focus on maths, is part and parcel of the more general quantification trend.

This is bringing me into a broader area, so I will stop here with a bald statement.

Economics is a discipline. To my mind, the failures in economics have little to do with ideological wars, although these have had an influence. Rather, the failures in economics lie in the inability of economists to focus on what economics actually means. They are discipline failures.  

Postscript

In a discussion in comments with KVD, I referred to an earlier post I had written around this topic. KVD suggested that I should include the link here -  Saturday Morning Musings - the rise and fall of economics.

At the time I wrote this post, I had actually forgotten the earlier one. It's not bad and does flesh out some of the issues I refer to here, drawing inspiration especially from Robert L Heilbroners' The Worldly Philosophers:The Lives, Times and Ideas of Great Economic Thinkers (Touchstone, New York, revised seventh edition, 1999).

7 comments:

Anonymous said...

Hello Jim

Very interesting piece, made more so because of the links, and links and comments within those links.

You finished with:

“Economics is a discipline. To my mind, the failures in economics have little to do with ideological wars […] the failures in economics lie in the inability of economists to focus on what economics actually means”

Over in Henderson’s article, he writes (with approval) in part:

“Eltham called for a new economics "that corresponds more closely with the reality it purports to describe, which takes into account real human behaviour and falsifiable empirical observations"”

And the very first commenter, links to (I assume) his own blog, in which he quotes RBA Governor Glenn Stevens saying:

"I think what we've learnt is something that we knew or should have known all along which is that market economies are characterised by cycles, that human behaviour is driven by alternately greed and fear and that therefore economic systems are occasionally prone to this kind of instability. It's always been that way and it always will be..."

I would just like to make the gentle observation that if Adam Smith’s Wealth of Nations is taken as some sort of modern history starting point for this “discipline” then the above two quotes would seem to indicate that not much in the way of progress has been made in the intervening 200+ years.

Or is it just that economists are unable to explain in clear terms that which they study and seek; or that they feel their theories must be couched in such simplistic terms?

kvd

Jim Belshaw said...

An interesting comment, KVD. It reminded me of a post I wrote back in May 2009 Saturday Morning Musings - the rise and fall of economics - after reading Heilbroner - http://belshaw.blogspot.com/2009/05/saturday-morning-musings-rise-and-fall.html

H. reminded just how much economic theory was tied up in the circumstances of the time. Indeed, there was a air of pessimism at economics' failure to develop a unified commonly accepted theory.

I don't think, in fact, that such a thing is possible. I don't think that I ever did. To the degree that economics attempts to explain and understand economic activity, then it almost definitionally follows that economics will vary with time. Futher, there is almost an inbuilt problem in that economics itself affects the behaviour of the thing studied.

This does not mean, however, that economics has not come a long way since Adam Smith. If one things of economics as a process of thinking plus a tool kit, then we clearly have.

The difficulty I have with arguments such as Eltham's is that it places an unsupportable weight on the discipline.

Of course economics should seek to understand "real" human behaviour. Indeed, there has been a lot of writing on this. But what do we mean by "real' human behaviour? How does it affect the analysis?

Again, falsifiable empirical observations is a little bit slippery. All economic models or indeed analysis should be subjectable to empirical test. If it can't be tested in some way, then you have a problem.

I do understand where Eltham and the political economy people are coming from. If you look back at the post I wrote in May - Case studies in public administration:http://belshaw.blogspot.com/2010/05/case-studies-in-public-administration.html - one of the key problems that I had to overcome was the mind-lock created by the dominant economic paradigm held in Treasury. There is a lot in the complaints about neo-classical economics.

That said, part of my problem with the political economy people is that to some degree they want to substitute one dominant paradigm with another. Indeed, when I look at some of the assumptions built into Helen's current studies, they have actually had a fair bit of success.

If we can't have definitive all-encompassing models that explain the world, then what use is economics? Well, if you follow my argument about economics as a form of thought, a way of analysing certain types of human activity, then it provides a structured way of unpacking particular types of problems to determine assumptions and relationships. In turn, this allows testing.

Anonymous said...

Jim

I take your points, and wish to say more about your reply, and things generally, but having just now re-read your May 09 post -

http://belshaw.blogspot.com/2009/05/saturday-morning-musings-rise-and-fall.html

- I really think you should have incorporated a link to that quite excellent piece in your post today and also forward it to Henderson and/or New Matilda.

kvd

Jim Belshaw said...

Hi KVD. Have added the link as a postscript. Have to find my new matilda password to do the second!

Anonymous said...

Jim

I’m burying this here so that my ignorance might only be on limited display. And I realise that what follows probably both conflates and confuses many issues, but here goes…

Your post heading is “The Fall of Economics”, but I think of it more as the “Relevance of Economics”.

I understand your past-tense quote “Resources were limited, so economics was also the study of the application of scarce means to alternative ends”, but am wondering how this now can be rephrased/rejigged to cover areas of activity such as the Internet?

Here we basically seem to have an abundance of resource, provided by unknown vendors/sellers, to end consumers/purchasers with little or no direct cost for that consumption or even remote connection between the various parties.

I know the above words can have specific meanings in specific economic environments, so accept my apology for hijacking them to my use. What I’m trying to get at is the relevance of past economic modes of thought to the way we, as consumers enjoy this resource. I guess what follows are examples of loss-leaders, but if my experiences are multiplied by the multi-millions, daily, surely that adds up to quite extraordinary “loss”?

Examples: Recently I “followed” my sister in law around England via Skype. In many areas where 3G access was limited or non-existent, we were able to clearly communicate via Skype over wifi. That is a product employed by us without any specific cost to ourselves – given that internet useage plans are so “generous” and hotspots are available free of charge. In other words I am consuming something for which I pay (I realise) but I am nowhere near fully consuming my monthly allocation. It seems such a waste of resource; at the level of Skype, and at the level of my monthly plan, and by the hotspot provider.

Two: In years past, Tom Clancy writes a book, the publisher prints it, I buy it to read and value changes hands along the way. That book will eventually turn to dust, so re-consumption involves re-production and re-supply to newer readers. But now, you produce this web presence, but are unable to be even remotely recompensed for the time involved. And any content you provide is subject to endless copying/duplication without charge, without citation, and without any degradation by its multiple ongoing consumption. How do you relate this sort of human production/consumption activity to economic theory?

Just musings as to aptness of “fall” as opposed to “relevance”. Feel free to kick off-line and/or ignore.

kvd

Anonymous said...

Sorry, what a mess!

Just struggling to change my mindset from resource, production, distribution, consumption, waste.

Unsuccessfully, kvd

Jim Belshaw said...

Hi KVD

There is a definitional problem that we had to address a long time ago in providing advice on industry structure, conduct and performance in the electronics, aerospace and information industries and inservices in general.

The definitions that are conventionally used for things such as investment focus on the physical, the tangible. This flows through into things such as accounting conventions. As defined, this makes it hard to analyse industries where rising capital intensity has little to do with physical capital. However, this doesn't mean that economics cannot be applied.

The argument here is to long to put in a comment. Better that I try to articulate it in a post.