History of Economics Playground

After removing all the historians of economics (and pluralist economists) from the economics department in 2003, Notre Dame University are now planning to shut down the department which they were all placed in. This at a time when the mainstream is ‘officially’ re-thinking its stance to pluralism seems like further indication that there is no such re-think going on. This has sparked comment from a previous faculty member, Teresa Ghilarducci and others like Fred Lee, the open economics blog and The Observer.

The original argument (if we ignore the in-fighting, politics, and bad feelings towards the pluralists-slash-historians) was that the Mainstream people were publishing in ‘better’ journals. Despite the fact that the pluralists and historians were more productive (in terms of research), their work did not go into certain star ranked journals. So the classification and ranking systems comes back to haunt us. We have already discussed the attempts to re-classify HET in Australia, and there has been some changes to classifications in Europe and Australia despite this (I seem to recall). But this is where the battle lines have been drawn. Not by us, but by economics departments who wish to appear to be doing ’serious’ work, and appear to be doing so to outsiders. The public debate on the value of mainstream economics will (eventually) die down again. Just as it did after the 1998 Financial Crash (which supposedly discredited the Scholes-Merton work), and after the 2001 bubble. When it does, we will be left with mainstream economists who are patting each other’s back for getting us ‘out of the crisis’, a public which evaluates the discipline on ranking metrics and a repeat of history once more. Or maybe there is something which can be done?

Paul Krugman’s New York Times article, How did economists get it so wrong? (September 6, 2009) was no doubt designed in part as a grenade to be lobbed at economics departments: to arouse anxiety and initiate discussion.  In that aim, if no other, it succeeded.  Last Friday, the grenade went off at Duke University, as the Center for the History of Political Economy hosted a department wide seminar to discuss the article.  The gathering was marked by a general sense of unease and unhappiness: some were annoyed by Krugman’s hypocrisy and tone and some were annoyed with the economics profession.  But many, as it turns out, still think that the greatest days of neoclassical economics are ahead of us and were very annoyed with Krugman for suggesting otherwise.

A macroeconomist, an economic historian and a historian of economics introduced the seminar.  The macroeconomist, clearly angered, promised not to speak for long, save to tell those assembled that the article demonstrated ignorance and vitriol: most of Krugman’s accusations were not true: macroeconomists were always trying to incorporate money and the financial sector into theory.  And as for Krugman’s argument that economists think that the more mathematically beautiful the model the better, nothing, we were told, could be further from the truth.  Testing theory against reality is all that matters to this macroeconomist.

The economic historian was less personally offended.  Krugman had raised some fair questions.  After all economists had not been sufficiently vocal in alerting the world to the unsustainable nature of the past few years and perhaps the emphasis on modeling had produced a certain selective blindness.  Finally, the financial sector had clearly not played the role in economists’ models that it should have done.  Still, the question remained: what is the ‘real’ problem here for economists?  Is this about the reputation of economists, a little bit of hurt pride; or is the economics profession actually part of the problem?  After all, the question was posed, how much influence does university economics really have on policy anyway?

Well, of course, I don’t know the answer to this question.  But judging from some of the comments from the room, it seems that most economists have a pretty high regard of their profession.  Not least of all Krugman himself for, as the panel member representing the history of economics pointed out, Krugman’s tone did not lack in arrogance.  For a start Krugman had placed himself above the profession even though he himself is as much implicated in his complaints as anyone else.  Moreover, were economists really to blame for the financial crisis: wasn’t the real problem with failed regulation, rather than economic theory?

Now it’s a funny thing.  Neoclassical economists working within the mainstream, either general equilibrium-ites or Chicagoans wouldn’t, I suspect, profess much love for Krugman, but they certainly do share his opinion when it comes to the importance of economics.  Thus we were told: if only the incentive structures for risk managers had been right, then these managers would have flagged up the risks to their bosses that were, apparently, all too evident in the value-at-risk models.  So the problem, it turns out, wasn’t the models (based as they were on only a few years data), but that economist hadn’t ALSO designed the internal management incentive structures.  But if you remain unconvinced by this then there was even more hubris to come.  It’s only a matter of time, we were told by another attendee, before the neo-classical approach can truly meet its destiny and provide a unified theory of everything (in the economy, just in case you wondered).  House values, financial sector leverage and option pricing, just three problems that will in time be solved.

So there you have it.  Perhaps those who thought that economists (including Krugman) were overstating their role in causing the crisis were right after all.  But, never fear, in the future ‘the general neo-classical theory’ of economics would be there to guarantee that things could never get of control again.  Well, that’s a relief.  Alternatively of course, some might suggest that the real battle in the room was between relative delusions of grandeur: the delusions of those who think that economists had caused this crisis and those who think that economists will in the future ensure we have no more.

To be fair, there were some dissenting voices in the room.  One contributor argued passionately that economics had reached such a level of arrogance that almost no economists were now taught basic skills, like how to read a balance sheet, a skill that would apparently have alerted many to the impending problems at the banks.  Another contributor suggested that economics could never be equipped to be able to definitively say when an asset was overvalued.  Modern economics after all is based on the idea that value is a function of the buyer’s personal assessment of value and utility.  How could economics ever say for sure that someone was overestimating what something was worth to them?  Were not questions about inflated asset prices moral and social questions beyond the realm of economics?

Still one suspects these comments fell on deaf ears.  As another contributor pointed out, the incentive structures in the profession were all wrong.  Such was the structure of modern universities that graduate students were so invested in current ways of thinking that they were always going to be unlikely revolutionaries in the discipline.  Economists misunderstanding incentive structures, institutions do play a role after all?? Never! I refuse to believe it!

Poetry pops up the strangest places… Stephen Ziliak was recently in the news for inspiring Haiku Economics, and I had gotten used to enjoying Voltaire’s prose on economics, but I was not expecting to find poetry in the US Office of Price Administration’s archives from the Second World War. But there it was, the poem “On Economists” from Fred Warner Neal at Harvard to Richard V. Gilbert, apparently unpublished, but in many places so very very spot on – even today. Neal wrote Gilbert that he was “delighted that an “economists’ economist” like yourself liked it. I don’t know how well some of the boys up here appreciated it”, and I think you’ll enjoy it too.

To avoid filling up the whole blog I have cut the poem at the third stansa, but click and it will fold out in all its glory, including some nice insights into 1943 economic thinking from the heartland of U.S. Keynesianism.

On Economists, By Fred Warner Neal:

Seeking cycles small and large,
Economists are want to barge
Upon a theory, here and there,
Devoid, perhaps (at least quite bare)
Of any rhyme of cogent reason
For being, now or in any season.

With scissors they seek to analyze
Things that never never crystalyze
Into reality, and plot curves smooth
That never will be, and try to soothe
Their brows, on fire for failing
To stop the leaks by only bailing.

Does the Margin fix the cost?
Debate on this means much time lost.
Some hide logic ’neath a hedge
Claim cost fixed at, not by, the edge;
While others, splitting hairs with sabre
Base their theories all on labor.
Or maybe on the land where sat
Once the mighty Physiocrat.
Read the rest of this entry »

The current crisis questioned the extent to which economics has produced “useful” knowledge, in particular the areas of macroeconomics and financial economics. There has been another round of criticisms and of defenses that may interest historians and economists alike.

The Economist, Jul. 18th 2009, Cover

The July 18th edition of The Economist had in its cover a melting wax-like book titled “Modern Economic Theory”. In it there are two interesting articles appraising the developments in macroeconomics and in financial economics (and the hypothesis of efficient markets) and the problems these economists have had in dealing with the crisis.

After that, the Nobel Laureate Professor of Chicago, Robert Lucas, has written an article to the magazine noting that:

both pieces were dominated by the views of people who have seized on the crisis as an opportunity to restate criticisms they had voiced long before 2008. Macroeconomists in particular were caricatured as a lost generation educated in the use of valueless, even harmful, mathematical models, an education that made them incapable of conducting sensible economic policy. I think this caricature is nonsense and of no value in thinking about the larger questions: What can the public reasonably expect of specialists in these areas, and how well has it been served by them in the current crisis?

Lucas goes on to defend Fama and the efficient hypothesis market and to argue against the “caricatures” in The Economist’s briefings (in the macro piece, mainstream macroeconomics is referred to as “dark age of macroeconomics”). He recasts his view that the crisis is an adverse shock that has being dealt with by many macroeconomists over the last two years. In doing so, these economists have “drawn on recently developed theoretical models when they judged them to have something to contribute. They have drawn on the ideas and research of Keynes from the 1930s, of Friedman and Schwartz in the 1960s, and of many others.”

More recently, a new round of criticisms has started in the United Kingdom. The Queen has visited the London School of Economics on November 5th last year and has asked there why had no economists noticed the crisis that was on its way? On July 22nd, 2009, Professors Tim Besley (LSE and external member of the Bank of England monetary policy committee) and Peter Hennessy (Department of History, Queen Mary, University of London), on the behalf of the British Academy, wrote a letter to the Queen giving the consensus view that emerged during a forum promoted by the British Academy a few days earlier, whose theme was “The Global Financial Crisis: Why Didn’t Anybody Notice?” They summarize this view as following:

So in summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.

A group of ten dissident British economists felt that Besley and Hennessy’s letter did not address the heart of the issue: “that in recent years economics has turned virtually into a branch of applied mathematics, and has been become detached from realworld institutions and events.”  They wrote another letter to the Queen explaining their position. Among them, one finds Sheila Dow (University of Stirling), Geoffrey Harcourt (Emeritus, University of Cambridge, University of Adelaide), Geoffrey Hodgson (University of Hertfordshire), and Malcolm C. Sawyer (University of Leeds).

Let’s see what comes next.

We know economists sometimes like to use past economists to construct a lineage to the current practice. They like the idea of progress and appreciate triumphal histories. In reading Schmitt-Grohé and Uribe’s paper, “What’s News In Business Cycles,” I came across the following sentence (p.1, but the paper does have a page 0):

The idea that changes in expectations about the future path of exogenous economic fundamentals may represent an important source of aggregate fluctuations has a long history in economics, going back at least to Pigou (1927). Recently, these ideas have been revived in an important paper by Beaudry and Portier (2006).

Arthur Cecil Pigou (1877-1959)

The book by Pigou referred here is his “Industrial Fluctuations”.

Depite any rethorical device the authors may have employed, I keep wondering about the usefulness (for their audience of economists—sorry fellows, no way to avoid coming back to audience…) of such superficial “historical” claims. Why is it useful to have Pigou as one entry in a reference list of 14 items, most of them dated from the mid 1990s onward? Is it a way of showing one is “well educated”? Is Pigou a “giant” on whose shoulder one can stand? It will be interesting to see whether or not this sentence will be kept in the published version of the paper.

Historians of economics are well aware of the non-neutrality of the research methods economists use. Or are they? Sure, we know that also research methods – statistics, experiments, field observation, armchairs, you name it – have their histories. And obviously, that makes them an integral part of how economics developed. However, in this reasoning the research method itself has remained a passive and neutral information producing device. Jan Tinbergen became famous for combining mathematics and statistics in a novel way, in which the resulting econometrics was and is understood as a tool that can be applied by anyone alike. Similarly, Fogel and Engerman applied a whole bunch of empirical methods to the history of slavery, in which their tools might have been inappropriately used or interpreted, but in themselves were have been understood as neutral. Despite being aware that the tools have their own histories, historians of economics have essentially maintained a view of research methods as neutral and passive.

            I want to contest this view. Research methods are not neutral tools, but actors that actively shape economists’ view of the social world. The exact same experiment makes Vernon Smith and Richard Thaler see two different social realities, and makes these two economists develop their own theories in diverging ways. It is not just that economists like Smith and Thaler have different economic views, and in particular it is not the case that their views converge because of the laboratory experiment, data collection, or field experiment. Quite the contrary, the experiment actively diverges Smith and Thaler’s economics. Research methods are not neutral and passive tools, but actively manipulating actors who need to be treated as such.

You don’t find jokes about economic graphs every day. Looking for a catch phrase for a paper on visual representation and economics textbooks, I came across political satirist PJ O’Rourke’s Eat the Rich, subtitled “A Treatise on Economics”. On page 110, O’Rourke introduces an absurd diagram in which he relates “the number of pages of Econ text devoted to graphical analysis” to “the number of Econ students asleep in the lecture hall”.  On page 105, he summarizes the attitude of most undergraduate students toward the principles of economics class: “I. There are a lot of graphs II. I’d better memorize them III. Or get last year’s test”. Okay, that’s funny. And so I have my catch phrase.

What is not as fun, on the other hand, is the rather populist background that comes with that joke when we get deeper into O’Rourke’s book. What he really means, in fact, is that economic diagrams as well as other technical elements are thrown in the introductory course only to introduce socialist ideas, for example the idea that “all wealth is the result of criminal conspiracy among: A. Jews B. Japanese. C. Pirates in neckties on Wall Street” (Ibid.). One of the examples provided by the author is the Keynesian equation Y=[C+I+G+(X-M)]/(1-c). He notes that “it’s hard to imagine applying the above formula to any ordinary economic question, e.g. should I put my bonus in a certificate of deposit or buy new stereo speakers?” (p. 106). O’Rourke may well have his definition of “economics” from Aristotle rather than from Robbins, so it’s easy to disembowel the guy for writing that but most importantly, all of the chapter is to show us that mathematical economics is simply socialist thinking dressed in fashionable mathematical nonsense. I thought this kind of thinking had been thrown out with McCarthyism. So this is not so funny, after all …

What is a bit funnier, on the other hand, is that the opposite discourse has become as fashionable: thanks to Sonja Amadae, we know that mathematical economics and assumptions about rational behavior necessarily imply the defense of capitalism as a political discourse. Amadae is probably more researched than O’Rourke in her demonstration but the similarity between the two theses is that mathematical economists are just idiots who are not even aware of the political implications of their discourse. For O’Rourke, they’re just a bunch of socialists in disguise; for Amadae, they just underwrite the protection of big corporations. I am not naive: I would not assert that there is no politics in methods. I just wonder whether it is too much asking for more subtlety…