A great divide holds back the relevance of economists

By Mark Thoma
July 26, 2011

By Mark Thoma
The opinions expressed are his own.

Reuters invited leading economists to reply to Mark Thoma’s Op-Ed on the “great divide” in economics and will be publishing the responses. Here are responses from Ashwin ParameswaranJames HamiltonDean Baker, Lawrence Summers, and a recap of Paul Krugman’s.

How much confidence would you have in the medical profession if the teaching faculty in medical schools had very little experience actually treating patients, and very little connection to – even a lack of respect for – the practitioners in the field? Would your confidence be improved if medical research had little to do with the questions that are important to the doctors trying to serve patients?

Unfortunately, that’s a pretty good description of how economics has been practiced. The questions academic economists are trying to answer have little connection to the problems faced by business economists trying to help their firms make good, profitable decisions (and vice-versa). And though academics pay some attention to government policy, particularly Federal Reserve policy, addressing the problems faced by government economists trying to help policymakers make the best possible choices is not the main focus of this research.

This division between academic, government, and business economists is driven by the fact that economic theory and econometrics can be used for two different things. One is learning about how the world works. These “how and why” questions are the focus of academic research. For example, academic economists try to understand why demand curves slope downward, how business-cycle fluctuations in GDP come about, and how prices are determined in market economies.

The other use of theoretical and empirical economic models is forecasting, for example predicting where the economy is headed so that businesses can react accordingly, and predicting what might happen if various government policy proposals are implemented. These are the “what if” questions that economists in government and business are most interested in. What will happen to tax revenue if business taxes are cut? What will happen to the demand for my product if the Fed raises interest rates? What is the most likely course that the economy will take?

Again, a comparison with the medical field is useful. Science can help us to learn about how the body works, and that certainly aids our efforts to battle disease. This is an important area of research, and we wouldn’t want to cut it short. But knowing how the body works isn’t enough, we also need the ability to diagnose current illnesses and to predict when someone is going to get sick. In addition, we need to have treatments available to fix the problems that we’ve identified. Periodic checkups, for example, allow us to predict who might get coronary disease, and then take action to avoid much bigger problems down the road.

Academic economists have emphasized the “how it works” part of economics; in econometrics, for example,  the focus is on hypothesis testing to determine which model of the economy is best, rather than on forecasting the future of the economy. Academic economists do evaluate policy proposals theoretically and empirically, and they do provide forecasts of the economy. But forecasting in particular is not the main focus of their efforts, , and they’ve all but ignored – even looked down their noses upon – forecasters and practitioners in the government and business communities. They are often viewed as data grubbers who use old-fashioned models and techniques, and are thus unworthy of attention from high-minded academics.

However, a few practitioners saw the housing bubble coming. Shouldn’t academic economists try to learn from them? What did they see that the academics missed? In addition, if the practitioners in the field are unaware of or do not have the technical ability to use the best approaches to the problems they face – criticism from academic economists over how business economists used value-at-risk models prior to the recession comes to mind – whose fault is that? Shouldn’t academics try to help the practitioners get over this hurdle instead of turning their backs on the problem, and then looking down at them when they don’t use or misapply cutting edge techniques?

The failure of academic economists to predict the crisis shows just how costly such insularity and arrogance can be. The patient (the economy) didn’t need to have a heart attack (financial meltdown), because even though the signs were there, the academic community had little interest in learning how to read them, let alone in developing early warning and intervention strategies for bubbles and other problems. The Fed does some of this, of course, and the financial crisis has motivated some academic interest in developing early warning systems that would have helped us to identify and do something about stock, housing, and other bubbles before they inflated to dangerous levels.

The medical profession would do much worse without connections between the practitioners in the field and the how-it-works types in the labs. The questions researchers ask, for example, are shaped by the needs of the practitioners trying to prevent and cure illness. What types of tests can doctors do in their offices and labs to quickly and reliably indicate the current health of a patient and to forecast future health problems? In economics, if reliable tests for bubbles had been available to business economists, that could have saved the economy from considerable losses.

Economics has lost the connection between the practitioners and the academics. This may have something to do with the desire among economists to become more of a science – a heavy focus on theory and math is the result. But no matter the cause, if we want to do all that we can to avoid big economic problems, and if we want to use the feedback from those testing economic ideas on real world applications as a way of better understanding how the economy works, then we must reestablish these ties.

PHOTO: A stethoscope rests on a container of hand sanitizer inside of the doctor’s office of One Medical Group in New York March 17, 2010. REUTERS/Lucas Jackson

53 comments

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The problem with economists is that they all believe that economies are managed by supernatural forces that “right” them based on criteria that is, at best, arbitrary. The rational ones who aren’t mathematically incompetent saw the bubble for what it was.

Posted by nondescriptuser | Report as abusive

how many tea party types support getting into the 2 wars we are in?
WE ARE AT WAR
who cuts spending during a war?
not patriots!

Posted by chjj | Report as abusive

As a scientist, let me tell you that it is possible to deduce laws, then test them, by merely observing phenomena. The economist only has a slight disadvantage.
There was an informant in the Watergate era who’s famous quote was “Follow the money.”
Instability, when it is due to a controlling party, will allow that controlling party to benefit from the instability. There is no motivation on the part of those who control the world to create stability, until they break the dog that they are wagging. That hasn’t happened since the great depression. We had a period of stability after that great breakdown. Don’t forget that that great depression was only cured when the world war forced even the most staunch fiscal conservatives to really pump those ever so evanescent dollars into the economy.

There is no money, there are only people, goods and services.

Posted by catraeus | Report as abusive

I think I owe oneofthesheep an apology for jumping to too rash a conclusion.

But I think he gets the cart before the horse. People in the developing countries seem to have fewer children because they don’t need them anymore to insure their own survival. But first look at the photos of refugees and count the kids. As I recall, refugees don’t seem to have large numbers of children and it is difficult to keep those they have alive. Having children is a survival instinct.

Big families happened in this country either with the pioneers on the prairies or expanding states – where they could at least be certain they would all eat – or in the early days of factory life with massive immigration during the later half of the 19th century. Their numbers have been shrinking rapidly with or without family planning. My grandparents lived with prohibitions against family planning of any kind and raised large families. Their children don’t seem to have practiced it either and yet none of them had more than two or three children. My generation has had even fewer. My generation knows about family planning but I’m not at all sure it really matters. I’m not sure they use contraceptives and they are all grandparents now. I never looked at their medicine cabinets.

With or without family planning- something happens to the urge to raise large families when people are absorbed into a specialized and industrialize society. The Chinese force it by fiat but the west seems to do it to stay within their means or to rise in careers.

You wanted a vision for the future. Three quarters of the earth’s surface is ocean. So much of the most dense development pressure seems to occur on the planet’s coastlines. That coastline could have a mirror image in off shore or even deep water floating development. Buildings are no heavier generally than land-based buildings or rather they don’t have to be. It is their shape and footprint that is the issue on the water. Ships used to be designed more or less with 2/3 above water and 1/3 below. Modern ocean liners seem to be much shallower and wider and are becoming more like tall barges or houseboats. It appears to be safer to weather a hurricane in large ship than it is to endure one on land. The ships are designed to withstand high winds. Tsunamis are a threat near shore or on land where the wave fronts are most obvious. In deep open water they are barely evident at all and the wave front moves rapidly but hardly disturbs the surface at all. You can look it up

On land, buildings go up when one can’t go wide. Land based development competes with agriculture and natural ecological systems. It must also compete with seismic movement and storms. Urbanization is spreading rapidly in the developed and developing countries to the detriment of all other uses. At least two New England states are becoming enormous suburbs. They have built-in enormous fuel costs for e heating and transportation alone. Those are not particularly productive uses for fuel. There is no point in denying the possibility of global warming. It makes too much sense as a theory.

The Africans are talking about developing the savanna and that could mean the extinction of already threatened wildlife. The areas nearer the hone of Africa – in the Sahara – have been experiencing droughts for at least 30 years. Global warming may cause greater desertification there.

The ocean is in a constant state of movement and it is known that wave action or current movements can be used to generate power more or less economically. If the power source is cheap – how efficient does the means of conversion really have to be? Development located where climates are more or less temperate could reduce the need for fuel for heating and cooling. It could even require less material for shelter. Transportation on water is the easiest way to move massive freight shipments. Telecommunications are making it possible to live anywhere. It is not too dreamy eyed to consider the possibility that the future of mankind could be housed between the tropics of Cancer and Capricorn.

I’m not talking water world. I’m thinking Venice or Amsterdam. Venice sits on islands and is built on piles that extended the shallow sandbars that were its foundations during the decline of the Roman Empire. One could do nearly the same thing without the islands. Development off shore means all the investment goes toward the building with little pressure from high land prices. It also goes toward buildings that can be moved easily without the threat of being trapped in areas of stagnation or decay. It could be possible to build cities without slums because slums tend to be caused by fear that investment will be trapped in areas of decreasing land values. It would not be difficult to move entire buildings.

I can’t imagine that space colonization is going to be a new frontier for any but those sponsored by industry or government, and/or are very wealthy or well trained. We are not likely to see the equivalent of the homesteaders of the mid west. It will require such a very disciplined and constrained life that it could made the Chinese or Japanese look like free living slobs. After all, anything done in space will be extremely expensive in as much as anything sent up there must be sent at least 27,000 miles up and will take some time to get there. They will never go “outdoors” to get a breath of fresh air. In fact – no one who lives there will ever breathe fresh air nor are they likely to drink fresh water. Any attempt to build earth like worlds could be centuries in the future. And it is difficult for so many people to accept the restrictions of conventional 21st century urban life as it is. Life in space could mean a life that must be lived under nearly military discipline and military life is a life without all the rights of civilians.

So much of the modern economy seems to be based on something other than older intuitive theories of what wealth meant or what it takes to move money or keep an economy alive. The developed world lives with a variety of subsidies. Perhaps it should aim them better? Before one attempts space wouldn’t it be wise to have a half way step to make life without Terra firma less of a shock?

Apologies to the author for drifting so far from the subject.

Posted by paintcan | Report as abusive

In the forth paragraph – it should have said “Buildings on water” are no heavier…. Modern construction tends to be light weight. Water is heavy at about 67 pounds per cubic foot. Salt water is a little heavier.

Posted by paintcan | Report as abusive

Paintcan:

You err when you state that your grandparents — who had large families on the frontier — didn’t engage in ‘family planning’. They did. They lived in a society which was very, very careful to ensure that men and women didn’t reproduce out of ‘love’ or ‘lust’ or carelessness. Instead, these people had children within a marriage sanctioned by a sustainable society. This is family planning, and it’s been proven to work over the entirety of recorded history.

Compare that to the Africans (whom you refer to as an ‘older society’, but who are, really, nothing more than human animals with no ‘society’ to govern their base instincts). For the most part, the affected Africans simply take what they want with no thought of the future.

Taxing civilized societies to support these human animals is the height of stupidity. As you know, it doesn’t actually help these human animals, because they die anyway. All it does is enrich the corrupt politicians who exort this money from well-meaning but unthinking Westerners.

Don’t be so quick to assume your uneducated Grandparents were ignorant and innocent. I would wager they knew a lot more about the world than you do.

Posted by Renaldo1 | Report as abusive

Countries don’t give money purely from the goodness of their heart and you combine a number of different funding streams and try to maintain that the issue is “taxation”. I didn’t say my grandparents were from the prairies. They arrived too late to kill off the aborigines.

My grandparents came from southern and middle Europe. They were low income or they would have likely stayed there. All the well-developed “human animals” that were managing to remake the face of Europe and swelling their numbers enormously were crowding them out. They were calling it an age of progress at the time. The native sentiments in New York where they landed tended to dismiss them as human animals. I’ve seen late 19th century newspaper editorials opposed to building codes in Manhattan, that dismissed the immigrant neighborhoods as filled with human animals that would kill themselves off to fit the lousy housing. They thought it was stupid to improve conditions too. The next line is usually – it will only spoil them and they will only make more of themselves if they are too well fed. A lot of academics economists would have used that line.

The developed countries of the world could easily write off aid to the developing world. And the developed world will very likely not listen to anything you say thereafter.

And don’t be coy, tell me what my grandparents knew that I didn’t hear about? No one gave my grandparents parents credit for family planning and I don’t know where you get your notions. The rule throughout history was to encourage as many children as possible to out pace infant and child mortality mortality and loss due to war.

Posted by paintcan | Report as abusive

@Mark Thoma, thank you. The “how it works” models seem to be designed by people with Aspergers who can’t grasp that you can’t make the people fit the model. (Sorry professor, but those with Aspergers seek out such professions as Economist and Professor, given the math and computer models involved and also, lack of need of social interaction as a necessary skill)

@Mulp, the sub prime bubble was like having a lot of old used cars, removing parts to sell later (fake notes and documents, not securitized) getting a crooked inspector to inflate the price (fraudulent property appraisals and ratings by S&P)and selling the lemons as brand new BMWs. (CDOs, using MERS as the facade )

@redou, you sir, are correct. It is the “greed is good” mentality. Curing the disease also means getting rid of the cause and of course those who caused the problems are the very people who are trusted to make it run efficiently… Bankers, Fed, Congress, treasury, ratings agencies, justice system … etc. (and of course the economic advisers)

Posted by hsvkitty | Report as abusive

Without getting into a bunch of different graphs like S curves and utility curves or the idea that the trading on Wall Street is actually a Mandelbrot formula, why don’t we talk about ‘real’ economics. I have worked for years and one truism that comes out is that they do not give raises or bonuses to the lower part of the economic spectrum (the 200 million that don’t make more than $100,000 a year) unless they have to. If they want to keep people or if it is the industry standard they will pay that wage, but they try to pay less every year, and they also pay less when hiring the same skill 10 years down the road. The nature of business is to do that with, unfortunately, most businesses today considering people as chattel that are a cost item similar to a bolt. People should be in a separate category.
The problem is that classical economics was tried for 150 years in this country. It worked well when the economy was small and agriculture based, where 99% of the people had or worked on a farm where they lived and had food to eat, whether there was a depression or not. As the industrial revolution took hold, a new type of animal was released, that didn’t care about people or whether they starved or not. It was only profit based, which is OK, but it needs to be regulated so that it does not get out of hand because the capitalist has a great advantage against the working man. Soon, our economy started having depressions every 10 years with everybody losing everything and the banker stealing everything and leaving town. This is why we started banking laws, which were gutted since Reagan got in and that led to the large losses that they were able to perpetuate on customers, because they did not have mortgage regulation or enough reserve funds. Classical economic was replaced by Keynesian economics, which worked great since the Great Depression, but Reagan started this Neo-classical trickle down, Voodoo economics, which is basically a very complicated scam that has been perpetuated on us by people without any regard for what will happen to America. Now we find that neo-classical economics doesn’t work either and the people that are behind it do not believe in it either – they just want to steal everybody’s money and to hell with America. To hell with them and everybody that is opposed to them please vote in the next election and do not let them stop you no matter what!

Posted by builder7 | Report as abusive

@checksbalances—You are on the right tack from that point in 1980.

There was a take-off in the information technology that coincided with Reagan econ policy, making it look quite successful to some. Here was when the work of Bator, Samuelson, Pareto, Smith and Keynes should have come together.

Anyway, a take-off in bio information tech could and should happen right about now. It would significantly reduce health care costs—healing is cheaper and better for the whole crew.

Posted by sailorlw | Report as abusive

More worrying than the division between the academic and practical economists is the parts where they agree : Most Economic ‘Theory’ is just plain nonsense : for example the much touted MV=PT that is used to explain the “Velocity of Circulation of Money’ – well there is no ‘circulation of money’ to have any velocity : Butchers do not use their retail takings to buy consumer goods from bakers – they use it to pay off debts back along the supply chain… to the farmer and the landlord… and ultimately the bank – the money is destroyed when the loans are repaid. The likes of MV=PT which is actually a tautology pretending to be an equation does not prove that there is a “circulation of money” that has a “velocity” it is just a ratio that they defined V=PT/M that means nothing much at all in reality.
You can create it yourself from 1=1 : multiply both sides by MPT to get MPT=MPT then divide both sides by M to get MPT/M = MPT/M.
On the left, bracket it so it looks like : M(PT/M) and on the right cancel the M’s on the top and bottom to get : M(PT/M) = PT. Now define PT/M to be = V and give it a grandiose sounding name like the “Velocity of Circulation” and replace the (PT/M) with your new defined V to get MV=PT. All theses terms can be anything at all : M can be the amount of money M0 or M3 or M5 or the amount of Martians in the White House, similarly the other terms can also mean anything at all P can be the amount of peas on your plate ! The trick is, as you’ve defined one of the terms in the “equation” ‘V’ using the other terms in the equation : P,T & M the ‘equation’ will always be true – it’s a definitional tautology – it’s little more than a kids “add it to the first number you thought of” number trick. At base, the split is not between one type of economist and another it’s between Economists – who don’t know how to do equations and Mathematicians who do and between economists who don’t know how to do Double Entry Booking and Accountants who do.
The latest batch of economists appeal to Ricardo to justify Free Trade – Well Ricardo’s idea was essentially “let’s specialise” otherwise known as “let’s put all our eggs in one basket and de-skill in various industries”. To an extent, it might be allowed that it has something to commend it to some extent, but now with the WTO allowing “Freedom of Movement of Capital” as well as goods and services this allows the Chinese do Uni-Trade – they sell goods to us and use the money to buy – not our goods in return (al la Mr Ricardo) but to buy our companies, land, bonds, shares and turn us into Tenants of our new Chinese Landlords in our own Country – there is no theory of International Trade that says this Uni-Trade is a good idea – it’s a one way ticket to the end of western Civilisation.

Posted by de_chandos | Report as abusive

@de_chandos- that’s very clever what you did with the equation but it is slight of hand. All equations must have both sides equal.

You claim V=PT/M (the Wikipedia definition uses different letters) doesn’t make sense. But it does because one can fit numerical values into the equation. Whether the numerical values that are inserted are valid or the results obtained are valid is your point.

How about W=V/A, the power formula, or E=MCsquared? ( sorry I can’t type exponents). It isn’t possible to actually demonstrate the speed of light times the speed of light. It is derivative of A=VT, the acceleration equation.

If what you are saying is that money is not a physical quantity and therefore can’t be measured, than what is it about it can be measured? It is certainly real enough in book keeping ledgers. So it must be in the bookkeeping where the money supply expands or contracts or even vaporizes during market crashes? The fact that wealth can vaporize on the stock market is due to the fact that stock traded at one time for a specific value is sometimes assumed to be the value of all the un-traded stock and people act accordingly, and also due to the fact that stock bought for one price may rise or fall by the time it is sold. That may be the BS of the market place because the valuations may have nothing to do with sensible reasons. Fear and greed is the engine. If all the stock traded at once it would have a low value. But that’s the way it’s done and I suppose there’s no point in arguing about it. Here you have a point – is that M or PT?

Transactions obviously have speed or investment houses wouldn’t be building high-speed computers to trade in milliseconds. Isn’t that a good demonstration of V?

And individuals and countries measure their wealth relative to each other all the time. It doesn’t seem too difficult to determine when a country is rich versus one that is poor. Isn’t that a good demonstration of PT? It is obvious that a wallet with thousands of dollars has more money than one with a few dollars as long as they are in the same currency. But the relative value of currencies doesn’t seem very reliable and may be as explosive as splitting atoms.

But in many ways, money is no more real than the probable location of an electron or nuclear particles, yet that hasn’t stopped physicists from writing about them or devising formulas to try to define their behavior. And they get results from their equations.

For the rest of your comment, how does the flow of manufacturing to low wage countries (and that is something of a mirage too if you live in the low wage country – all things being relative) qualify as uni-trade?

Japan and the OPEC countries could have been labeled uni-traders a few decades ago. The difference between China and Japan and OPEC was that they were converting some of their dollar surpluses into real estate and other assets in this country. China buys debt.

You charge there is something wrong with the Chinese alone and that it will bring about the death of “Western civilization”. The Chinese have become just as westernized in the exchange of whatever it is everybody is exchanging. I’m sure they have the same question.

If were going to consider pointed questions: what makes “western” civilization western? Someone warned, “Never the twain shall meet”. Too late – what happened because they did and so far it isn’t terminal and even it could be, how is anybody going to decide and write the death certificate? Why would anybody believe the coroner?

Posted by paintcan | Report as abusive

Sorry I made a mistake – W=VA. Watts equals Volts times Amps. I’m not an electrician and can’t remember formulas unless they bite me. But that’s a handy one to know for daily use. Another one that is handy is Hp=W/750 (Horsepower equals Watts/750).

All equations could be reduced to 1=1. Some are 0=0 And you didn’t debunk the equation you just caricatured it. You left out the prospects that some transactions can result in substantial profits. It can sit in a saving account and eventually be lent out (or cover prior loans?) or be immediately reinvested in high-speed trades. Where’s money circulating faster?

Posted by paintcan | Report as abusive