Tuesday, October 18, 2011

In response to “Economics has met the enemy, and it is economics”

(The article this post refers to was published in the Globe and Mail, Saturday, Oct. 15, 2011 6:00AM EDT, Last updated Sunday, Oct. 16, 2011 12:13AM EDT)

I was puzzled by the impression this article gives that there is “one” economic theory. Perhaps it is worth to remind the readers that although economic theory dares to predict some events, this predictions are done under very specific sets of assumptions. And, as we keep reminding our students, departures from those assumptions dramatically change those predictions. Stating that "the" (one and only?) economic theory only upholds efficient markets and frowns upon all forms of government interventions, only tells me that these people are very selective in their economic readings and that they missed the lecture on externalities and market failures. The article provides a partial view of the theory of rational expectations, but it fails to mention that this theory only provides a benchmark for how markets function (or rather should function) when, among other things, there is full information, agents are all identical and there all the costs and benefits of a transaction can be accounted for. Most economists, theorists and interested citizens with common sense recognize the theory of rational expectation for what it is, a useful tool. And the job of many theoretical economists has to do with learning what happens when these assumptions are not true.

It is childish and naive to blame "math" for the economic crises. Abstraction is not, it just cannot, be the culprit here. The problem does not lie with rationality or math, but with the way models are interpreted and used in politics and public life. As in all other sciences (natural or social) economics has "good" theory and "bad" theory, the good and the bad having nothing to do with the morality of the results or their mathematical complexity but with the transparency of the logical link between assumptions and propositions. Good theories provides a framework for thinking about a problem, outlining the plausible main forces behind it. It gives direction and provides its own limitations. It may or may not use math, although it will almost always use abstraction - how else can you reduce the complexity of society to a tractable problem? All the other disciplines mentioned in the article (sociology, statistics, psychologists or anthropologists) and a few of the new branches of economics the article mentions use abstraction, and some of them even use math. “Bad” theory, on the other hand, fails to uncover the main issues behind the problem, hides the assumptions leading to the conclusions and present logical failures, regardless of the degree of mathematical sophistication employed (which can be plenty as well).

Blaming economic theory for the recent market collapse is like blaming Einstein for the bombing of Hiroshima, or thinking that we would be better off without any of the physics development that could have led to nuclear bombs. Despite what the article wants to imply, neither natural sciences, nor social sciences have a moral dimension. Knowledge is just knowledge. What we chose to do with that knowledge is up to all of us.

Wednesday, October 12, 2011

Left and Right together

Sometimes it seems, especially in the US, as if left and right can't find common ground. In a surprising exception to this rule, the Health Impact Fund recently added to its advisory board Ken Arrow, a Nobel Laureate in economics, and a key contributor to our understanding of the operations of the market mechanism, and Noam Chomsky, one of the most cited academics in the world, whose perspective is much more focused on the abuses of those who dominate markets.