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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actually, a lot of academic medicine is no different.
I have experience in the field of drug resistant bacterial infections (super bugs, MRSA, c diff)
there is an awfull lot of academic medicine that is removed from reality.
For instance, it is clear that we have an epidemic of childhood obesity and type II diabetes in this country, an epidemic that is caused by social and economic factors (subsidys to sugar, when we see a donut as a toxic substance like a cigarette, we are making progress)
yet academic doctors treat typeII diabetes as a medical condition

Posted by joeenuf | Report as abusive

Maybe what causes the gulf between difficult academic disciplines such as economics and the more practical issues of life is that the more practical issues of life are usually grasped intuitively. The voter and politicians don’t have a lot of patience with theory. It’s rare to see politicians with strong academic backgrounds. And people don’t trust theories. But they gobble up, and cobble together ideologies like they were mother’s milk.

Ideologies don’t even try to be systematic, at least not the stuff that gets disseminated by blogs and media outlets. The impatience with academics is as old as Jonathan Swift and as modern and notorious as Mao’s Red Guards and his program to reeducated urban elites on collective farms. I doubt that anyone ever asked those “reeducated” academics whether they learned anything useful. They were told what to believe.

Theorists don’t like to leave any question unanswered. Employment, on the other hand, usually requires adherence to standard operating procedures and to work within one’s area of competence. And even if they have the theory – a difference in opinion among theorists can blunt it’s effectiveness. Economists really don’t have anything as tangible, or such a model of a compact system as the human body is, to work with.

You may be exaggerating how scientific the practice of medicine really is. The theory and science may be superior to the delivery.

Gold has such a strong appeal world wide because most people generally don’t know much more about the almost complete abstraction we call money than to give a token in exchange for a good or service. Gold tends to be the most primitive and believable token and devotees tend to forget that it is really just another commodity.

BTW – Will a reader with one intro econ course in college get much from the book “Economic Theory in Retrospect” by Mark Blaug? I not only don’t fully understand why supply and demand curves slope – I can’t quite understand why they are curves? I “attend the course” every few weeks when I do my laundry. Is there an easier intro?

Posted by paintcan | Report as abusive

Mr. Thoma, congratulations for having the courage to take your field to task. I am convinced that there are no solutions to our economic problems that will be found in the realm of politics. It makes little difference which party or ideology is in power when they all take their economic advice from economists who basically adhere to the same dogma and remain focused on one thing – macroeconomic growth. It’s the field of economics that must change if we are to have any hope of fixing our economy.

Among the other sciences, nothing is sacred. Everything is put to the test and old theories give way to new when the data and facts prove them wrong. This is what’s wrong with the field of economics. There is one parameter of economics – indeed, the most important parameter – that no economist dares to tackle. I’m speaking of the economic ramifications of population growth. Ever since the beat-down endured by economists following the seeming failure of Malthus’ theory, economists have steadfastly refused to ever again consider the subject of overpopulation, and anyone who does is immediately dismissed and riciculed as a “Malthusian.” Economists are united in their response: man is ingenious enough to overcome any obstacle to further growth.

Perhaps man is clever enough to stretch resources and mitigate stress on the environment indefinitely. But, since it’s impossible for population growth to continue forever, even if we tried, shouldn’t economists at least be curious enough to ponder what, then, will bring it to an end? If they did, they might discover the relationship between population density and per capita consumption, and the role that an excessive population density plays in driving down per capita consumption and, consequently, in driving up unemployment and poverty. And they may discover the role that disparities in population density play in driving global trade imbalances in manufactured products, the imbalance that now threatens to collapse our economy.

If the field of economics wants to better understand how the economy works, then it must be willing to consider the impact of every parameter.

Posted by Pete_Murphy | Report as abusive

There is something called hard sciences (eg. physics) and soft sciences (eg. economics). Macroeconomists, like Thomas, have been fixated on their econometric models – in which variables such as *behavioral economics* cannot be quantified or fixed as a constant/fixed variable. Consequently, academic economists got further and further away from real world economics – ie. behavioral economics.

The other area of academic focus should be *political economy*. I don’t know how many US academies today formally graduate Ph.D.’s in political economy. One would think in a world of globalization, the notion of global political economy would find a nitch in academic centres of learning today.

The last academic proponents of the subject was Gunnar Myrdal (Sweden) and John Kenneth Galbraith (USA).

Posted by hariknaidu | Report as abusive

The thing is, basic economics offers all that was needed to see the bubble:

1) capital assets always depreciate over time – classically, “a car loses half its value when you drive it off the lot” – houses are no different

2) economic profit represents economic inefficiency, either monopoly or other obstacles to a free market – if the price of something is far in excess of its cost, and increasing, something is seriously wrong

The housing market was like buying a car off the lot, and onto a used car lot the next day and selling at a profit, and more astonishingly, driving it for a year or two and then selling it for 50-100% more than you bought it for.

But perhaps I’m so attuned to housing bubbles because I bought my house in what I was sure was a bubble in 1986, but wanted the house to live in for decades, and was selling my old house for a huge increase in five years in just five days of listing. What I wasn’t expecting was a 20-30% fall in prices in a year. In 25 years tracking my house price, it has gone up only as fast as inflation, except from about 2002 to 2006 when it was about 30% higher in price.

Posted by mulp | Report as abusive

As Milton Friedman used to say, a good model is one that simulates well the past but is also capable of explaining unexpected things in the future. Arguably, econometrics is not the way to understand economics; it usually uses a set of parameters which attempts to forecast the future but can never explain the future, ie there is no economic theory in the modelling. Also, some of these parameters, such as income growth, may not be predictable themselves!
To understand economics, one needs to realize the effect of trade (deficit) on wage income and savings. But for more than 30 years now, economic theory, namely consumption theory, has taken a detour; Because of these teachings, we now have a generation of clueless economists!
On the other hand, if you apply the teachings of Adam Smith to Keynes and Friedman-Modigliani then you can reach to conclusions on why for instance growth can be positive and savings be negative and why consumption imports have a inverse relationship with change in personal savings. Why countries, such as China, suddenly have huge savings. In other words, to understand the wealth of nations and investments as buying a house, higher education or financial equity you need to know what factors affect income growth.
See my result and comments at http://knol.google.com/k/savings-and-gro wth#

Posted by cwucnspt | Report as abusive

I have a Master’s degree in Public Policy from the University of Chicago, and am continually dumbfounded at their ardent desire to hire academic economists over practitioners. In a normal economics department, of course, but the focus of the school is to train practitioners, not economists.

Posted by Adam_S | Report as abusive

“An economist is a man that can tell you anything—he’ll tell you what can happen under any given conditions, and his guess is liable to be just as good as anybody else’s, too.”
─ Will Rogers, Radio Broadcasts 5/26/1935

Posted by leslie20 | Report as abusive

“1) capital assets always depreciate over time – classically, “a car loses half its value when you drive it off the lot” – houses are no different.”

Buildings are not the same as cars. They are generally built of more durable materials and it is difficult to separate the land value from the structure built on it. There are depreciation schedules for commercial buildings but longer than for other assets like cars and machinery. And the building itself does not depreciate uniformly. The structure of the building could last for hundreds of years. The finishes are what wear out. The fact that depreciation of the asset is a write off, also forces renovations when no real need may exist. This is good for creating economic vitality but may be insane if the future brings scarcity of resources and a real need to watch ones energy consumption and waste generation.

Real estate tends to be more valuable the more that can be built on it.

The argument also ignores the impact of zoning laws that artificially limit the density of urban and suburban development. Communities are using zoning law to preserve whole towns in amber knowing full well they can increase the value of the real estate and restrict the area to the affluent only by making it too expensive for the “undesirables”. “Undesirable” is a magic quality that can include anyone without sufficient income. If communities could zone in reverse – i.e. exclude anyone with too high an income – there would be many who would try that too. But property taxes can do the same job of limiting too expensive development that might also pose a threat to “our town”.

The extremely arrogant comment by oneofthesheep suggests that it is in the self-interest and the right of developing countries to force the sterilization of what it deems marginal or unproductive people. If the commenter is serious, then he is also arguing that the developed economies, who are not only the greatest gluttons of resources – with little restraint of their ability to feed every desire however frivolous, also have a right to endanger far older societies that aren’t as dependent on all the luxuries the developed world can’t imagine living without. Take a look w Google earth and Darfur and notice how little it takes to live and still have offspring.

Ask yourself – oneofthesheep – who is most fit to live? The immensely obese man who can’t walk without artificial means or the man who can still walk on his own two legs?
Who has the right to sterilize the other? The fat man may be living in a fantasy of his own invention.

Posted by paintcan | Report as abusive

One more thing – China doesn’t suddenly have “huge savings”.
They have been building their economy with “slave labor” for over 50 years. By slave labor – I mean that they were using collectivized efforts for decades and only within the last 20 years have they become the better-paid manufacturers for the globe. They concentrated on capital formation. Only now is the Chinese consumer being “re-educated” to shop till he drops.

If you take a look at popular mythology – like Feng Shui sites on the internet- you can see all sorts of knick-knacks that celebrate wealth and savings. Feng Shui is a lot older than the current regime.

Posted by paintcan | Report as abusive

I think the same thing is happening in many fields including the medical field. Knowledge has taken us to wonderful frontiers of discovery, however, we lack a way to implement those discoveries. In addition, we have many more educated. Educated does not mean intelligent. Unfortunately, too many people educated beyond their inteligience muddy the water because it permits the moderately intelligent to the drown out the voice of true genius. You know the old saying, too many cooks spoils the broth.

Posted by SeaWa | Report as abusive

Whenever there is MONEY involved – TRUTH will be hard to find.

There is a lot of MONEY involved in Medicine.
There is a lot of MONEY involved in Economics.

So doctors will continue to get paid for treating SYMPTOMS.

And Economists will continue to get paid for treating the SYMPTOMS.

Curing the Diseases, Medical or Economic –
means Someone in Power will not get Paid.
So it won’t happen.

Posted by redou | Report as abusive

Most economist have contributed nothing and in fact a very good case could be made that the policies they have spouted have actually been destructive. Using ones common sense would have resulted in better outcomes. They fail to see that economics is not a science but an art that constantly changes along with human interaction. It cannot be modeled (as we have seen time and time again the models have failed….at which in everycase they say we only need to tweek the model again)as the model is only as good as the knowledge of how humans will react to various inputs…none being very consistent….that’s why they always want to use the constant of all humans act “rational” all the time….it is the only way the model would tell them anything but even that is false so give false answers.

Posted by KarlMarx | Report as abusive

As a person who does not posses the academic credentials of Mr.Thoma and certainly not of a Dr. Krugman but has an undergraduate degree in accounting and economics with a decent measure of common sense, I take exception to his assertion of the arrogance of academia to predict or see the economic crisis. Most of what was and had been going on in the area of credit/finance was a prescription for disaster that even my neighbor who didn’t get past third grade predicted it terms of the meltdown. We had banks no longer acting as banks in the traditional sense after the safeguards of the Glass Steagall Act had been removed at the end of the Clinton era. Banks no longer had any interest in the mortgage loans that they made, as we are witnessing today with the robo-foreclosures it is difficult to now who the mortgagee is. If you don’t have money at risk you don’t pay attention.

How does one whether an academic or practitioner predict the level and consequences of epidemic greed. What economist has access to the the practices of rating agencies that were cooking the books and doing as instructed by the banks packaging credit to investors. Who could have predicted that Alan Greenspan would have had the chutzpah to make such a blatant assertion that Social Security was a threat to our nation’s financial health but that he saw no housing/credit bubble. Who knew except a few insiders who were sounding the alarm bell that the SEC was not minding the store.

Nevertheless, as my neighbor observed we had Wall Street bankers out of control, we had stagnant middle class income gains and skyrocketing home prices bolstered by cheap abundant credit, consumers were on a buying binge paid for with plastic and we were off shoring jobs that previously paid an American a living wage by the millions.

I submit that this did not require a doctorate in economics or the world’s most sophisticated economic modeling to predict, as my neighbor Sam said “It was just common sense and as plain as the nose on our faces”. Blinded by greed everyone was just looking the other way.

Posted by seattlesh | Report as abusive

For China, it is a “huge” increase in savings compared with what they had before Nixon visited China.
According to Clower’s Dual Decision Hypothesis, Keynes’ disavings is basically caused by errors in estimating income. For instance, you buy an expensive car expecting a nice bonus at the end of the year. When that bonus never materializes or it is compounded by the fact you were fired and stayed unemployed, then you have a disavings, i.e., overspending. Many will try to limit the damage by selling the car but over consumption already happened!
Due to exports, in countries with high wage growth such as Japan in the 1970s and 1980s, there was a large increase in savings. Once the jobs moved into China, Japanese personal savings level off and Chinese workers savings went up.
The important point to notice is that if change in savings is a function of wage growth then it is possible to have negative savings with positive growth, i.e., US savings.
Again, the summary and the links are in:
http://knol.google.com/k/savings-and-gro wth#

Posted by cwucnspt | Report as abusive

Economics is like physics before atoms, chemistry before molecules and biology before genetics & evolution. What relevance to reality all these very ornate & mathematically sophisticated models if they cannot predict with any accuracy? I am intrigued by all the claims of economics to be useful, but little evidence that it is useful.

Posted by MarkRB | Report as abusive

The answers to these questions are all found in the film “Inside Job”. Too many people moving between Treasury, Banks and Harvard… Looking objectively at economic theory ?? Too much money to be made elsewhere !! The problem is that many of them become politicians too, so the real problems do not get dealt with.

Look what happens too, when too many people move between News International and Scotland Yard…

Posted by b1quet | Report as abusive

It is some times easier to make a point through exaggeration. In this case it’s the academicians versus the practitioners, much like science versus religion. This doesn’t mean it’s false, just polarized.

A number of important factors besides the academic versus practical have been left out of the equation that involves the public perception of economists.

First, the media: If the economy weren’t complex enough, we have a media that is largely untrained in economics, even less than meterology, let report on the economy frequently, often with unattributed sources. Even when they are attributed, the media rarely can comprehend that there are other points of view AND have no way to discern which might be the most reliable sources.

Second, Sources, bias and agendas: Reporters often don’t make a distinction between the comments of a Nobel Laurette in Economics and an analyst-economist from a Wall Street firm. Many of the economists quoted by the media work for companies that have agendas involving the government, its policies and its subsidies. This makes their prognostications suspect. The same company that gave triple-AAA ratings to mortgage derivative junk is also frequently quoted on the media regarding economic policy and predictions. Academicians on their part have different models that can result in varying predictions, but who has ever heard any of them explain the difference in the models and the varying results?

Third, Data: This is important. Most of the economic data is collected and reported by government agencies. Theoretically, it is unbiased. However, both the legislative and executive branches learned many years ago that statistics that can help them Gerrymander, can also impact their political lives such as with the unemployment rate.

The United States Department of Labor’s Bureau of Labor Statistics (BLS) used to report unemployment from a variety of sources and filled in big gaps (mostly long-term unemployed) with surveys and additional analysis. As the politicians discovered that high unemployment statistics were bad for their incumbencies, they found a way to significantly reduce the reported rate. “To save money”, the official unemployment rate was changed to “the most reliable” sources, the States. Unemployment applications and counts of those receiving unemployment benefits were now the sole component of the official unemployment rate. Those no longer receiving unemployment benefits were categorized, “No longer in the labor pool” and/or “no longer looking for work”, an insult to those who no longer received benefits, but were desperate for work.

This change in the official unemployment rate works great for politicians, but what does it do for economists and their models of real-world unemployment? Let’s provide an example. One source of such data claims that the real unemployment rate is typically about 70% higher than the official rate – in good times, and worse in bad economic times. Who says this, the BLS! They continued to survey and analyze – not saving any money – and report the “under” employment rate. They even claim that this does not report the real unemployment rate which is considerably higher, more than 100% higher during The Great Recession!

When models are based on incorrect data, who could trust the predictions of any economist? Why aren’t there economists screaming at the lack of unbiased data?

BTW, who decided that the only definition of a recession/depression is a positive GDP? Doesn’t every economist know that a breakeven sustainable growth rate is somewhere between three to five percent, recently pegged by the Council of Economists @ 2.75%? By that measure, the United States is still in a Recession. And, if a Recession lasts more than two or three years, isn’t that a Depression? That’s how most Americans would define it, but then, of course, they’re not economists nor among the two percent that is rich.

Posted by ptiffany | Report as abusive

Don’t economists still work under the assumption that a science must write out emotional reactions? Greed is an emotion. The classical economists base their analysis and models on people acting in their most logical self-interest. They don’t look at issues of illegality or fraud either. Those activities wreck the model.

Economists want their models to exist in a perfect abstract framework and can never really find that in human behavior.

I haven’t reached Marx yet in the Econ review, but have a general idea of his theory, but one thing is obvious. The theory outlined so far was written in a time before ubiquitous mass media and the feedback and self-reinforcement it creates. Smith was dealing with a world that was primarily agricultural. Marx was writing in a time when industrialization was becoming the rule of economic life. Neither of them could have imagined the extreme leveraging of modern life. Few people had mortgages in Smith’s day. Marx’s proletariat would have been renters.

I’m looking for the economic theory that theorizes commercial hype, advertising, corporate self-promotion, and the impact of all of those things on consumer choices. Is there an economic theory about monopolies that are just short of being illegal? Is there a theory about “keeping up with the Joneses”? Other than spurious Thorsten Veblen, I can’t think of any. Is there an economic theory of propaganda?

I know there are such studies touching on what “rational behavior” really is in economic decision making but they tend to cross disciplines with behavioral science and psychology and they aren’t dealing with farmers or factory managers. I don’t think the early writers had any idea what a middle class was? That may still be too difficult to define let alone to theorize about?

Posted by paintcan | Report as abusive

The real issue is that many economists are not practicing economics. Rather, they are practicing what today would be called political economy, the most important aspect of which is ‘who gets what’. Virtually every ‘economic’ argument or debate you see in the press is about who should get what and it all boils down to the people in line to get something arguing for and those who would rather get those resources arguing against. Economics as most people know it has been co-opted solely for this purpose.

I don’t think there is a huge problem with this, but I also don’t think an economist has much more to say about the issue of political economy than a historian, philosopher or hard scientist.

Posted by jeremycjohnson | Report as abusive