A great divide holds back the relevance of economists
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 Parameswaran, James Hamilton, Dean 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