Wednesday, May 14, 2014

Economic engineering...

Although back in the day I had a minor in economics. (I could have gotten a double degree if I could I could only have gotten my head around linear algebra, but alas...I was allergic to it). Anyhoo, I've always rooted around in popular economic thought when I could.

But two things have changed this radically. First of all, economics turns out to be ideal for bloggers. In fact, some of the best econoblogs may be replacing economic journals as a way of exchanging ideas and debating.

But bigger than that, I think is the conversion of economics into something!
As an econ blogger, I get the sense that this is exactly how many Americans still think of economists—as self-appointed defenders of the free market, spinning theories to show that greed is good. Watching those old Milton Friedman videos, I wonder if that picture might have been accurate in the 1960s and 1970s. But some big things have changed in the field of economics, and America should know about them. Three big changes stand out in particular: Econ today is more data-driven, far less politically conservative, and in general much more like engineering than it used to be.
From theory to dataIn a 2012 interview about the future of energy, Nobel Prize winning physicist Robert Laughlin exclaimed: “Economists are idiots!… They just sit around making theories!” And as recently as the mid-1980s, he was right. As economist Dan Hammermesh found in a recent study, the majority of the papers published in top econ journals in 1963, 1973, and 1983 were theoretical papers. But in recent decades, the digital age has dumped a torrent of new data on the economics world, even as new theories have become harder and harder to think up. The result is that, as of 2011, the percentage of theoretical papers had fallen to under 30%. In recent years, the hot technique has been “structural estimation,” which is a sort of blend of theory and empirical work.
What this means is that, more and more, economists are demanding of each other “Oh yeah? Prove it!” Back in the age when economic data was very hard to gather, all you could really do was sit around and philosophize about how people might behave. A lot of useful stuff came out of that philosophizing, but a lot of non-useful stuff came out of it too. Now, thanks to the information age and the tidal wave of data, it’s becoming possible to see what works and what doesn’t in many arenas.
In fact, data has probably made an even bigger advance than those numbers suggest. A lot of the “theory” these days is pure game theory, which resides in econ departments but could just as easily be regarded as a branch of math. The kind of subjects someone in the 1960s would have probably called “economics”–things like tax policy, trade, industrial organization, or finance – are much more likely to be data-driven than in years past, at least in the top journals.
From laissez-faire to liberalWhen people say “Econ 101,” they probably mean a world where free markets work perfectly and government intervention is always bad. But open an actual Econ 101 textbook—say, Greg Mankiw’s Principles of Economics—and you’ll find a whole host of reasons why markets fail. Economists have always known that “negative externalities” (like pollution), “public goods” (like research), and “incomplete markets” could clog up the plumbing of the free market. But since the 1970s, economists have also explored how information problems like “adverse selection” and “moral hazard” can do the same. Game theory, which has become more and more popular, shows many cases in which even perfectly rational people can reach a bad equilibrium that leaves plenty of “free lunches” uneaten on the table. Behavioral economics has documented a host of ways in which humans might not be rational, and institutional economics has shown how even rational individuals can act stupidly en masse.
In other words, the simple story of perfectly oiled markets that was created by pioneers like David Ricardo and Kenneth Arrow turned out to be only a base case–the interesting stuff that went on top of that has made everything a lot more complicated.
Maybe that’s one reason why econ is slowly losing its reputation as the “conservative science.” Or maybe it’s the end of the Cold War, meaning that economists no longer have to serve as a bulwark against the threat of communism. But whatever the reason, the facts speak for themselves. A 2005 survey by economists Dan Klein and Charlotta Stern found that most economists favor government intervention in the economy in a wide range of areas, including income redistribution, minimum wage laws, environmental regulation, anti-discrimination laws, and others (and that was before the financial crisis!). They also found that economists are more likely to vote Democratic than Republican by a margin of 5 to 2. But even the Republican-voting economists tended to favor some amount of government intervention in all of these areas.
And let’s not forget that the most famous and widely-read economist in America, Paul Krugman, is also a liberal pundit. The days of Milton Friedman “schooling young idealists” are long gone. [More]

Other factors are much clearer writing and the proliferation of amazing graphics. Add in easily and rapidly accessible data from industry, government, etc. and economics has definitely gamed up.

The result is many more laymen like myself are struggling through economics explanations that would have sailed over our drowsy heads in college. More importantly, we're finding out it helps us understand our world and our businesses.

1 comment:

Anonymous said...

Let's see...moral hazard, adverse selection, free lunches, government intervention...sounds like the basic building blocks of the Federal Crop Insurance Program. Sprinkle in pandering politicians and entitled farmer to arrive at today's debacle.