Expectations and accountability in Economics

mad scientist Mainstream economist and textbook author Greg Mankiw notes the current unemployment metrics and reflects on the accountability and effectiveness of the stimulus (see udpated graph).
This again raises the question of methodology in economics and the necessity for the public, politicians and economists to distinguish economic science from economic forecasting.


In light of the 9.7% unemployment rate in August, Mankiw looks back at the administration's argument for stimulus in January 2009 and the expectations it set. The Obama administration claimed that the rate would stay below 8% if Congress passed the bill, but would reach 9% by 2010 otherwise.

Regardless of this specific instance and outcome, the question is: how should economists interpret events and data?


In physics, variables can be isolated and experiments can be controlled and repeated. So, empirical results can settle debates and advance knowledge. Physics textbooks are filled with scientists, laws, constants, experimental setups and results, and quantifiable and improving predictions.
This contrasts sharply with economics, where data usually only feeds the debate and whose textbooks contain theoretical models and historical illustrations. As much as mainstream economists claim to adhere to the empirical methodology, they actually do not proceed by experimentally falsifiable theories and a track record of predictions.

If the desired effect happens (or the undesired effects only happen later), economists and politicians celebrate.
If the expected effect doesn't happen, mainstream economists claim the baseline was wrong (things were worse than anticipated) or the intervention insufficient.
Although the first outcome seems deceptively benign and only the second usually raises questions, they both risk harmful unintended consequences and share the same pretense of knowledge.


The empirical methodology fails because of two fundamental issues: irregularity (historical events cannot be reproduced, and there are no measurable constants in man's nature) and complexity (factors cannot be controlled, isolated and often even measured).

The praxeological approach to economic theory avoids these issues because it covers a different kind of knowledge.
First, it handles the issue of irregularity by relying on logical reasoning (deduction) on the timeless axiom of action, instead of observation (induction). As I outlined in my last post, this means that theorems describe what must be, and the interpretation of empirical results plays no role in validating the theory, just like for geometry.

Second, it solves the issue of complexity in reasoning by decomposing the problem, often using thought experiments and using the ceteris paribus assumption ("all other things being the same"). For example, ceteris paribus a legislative raise of the minimum wage causes a raise in unemployment.
That isolates causal relationships by controlling and fixing all other factors.

Finally, it leaves the issue of complexity in observation outside of the realm of theory and up to the unscientific interpretation and judgment of economic historians, forecasters and entrepreneurs.


Such an economic theory yields definitive propositions and a deeper knowledge of causal relationships than physics, on the basis of praxeology and the action axiom. However it does not possess the kind of quantitative forecasting power which made physics widely successful and useful. This is disappointing and humbling, but it is not a new realization and we should be honest.
During the 20th century the neo-classical schools tried to make economics into a different kind of science than it is and their predecessors recognized.
In addition to taking economics into a detour and confusing theory, history and forecasting under guise of progress, this has unfortunately caused very real damage to societies. We will discuss some examples of harmful policies later, but not before we look at some major theorems in the next few posts.

It is time for economic science to return to a sound methodological foundation, for the good of the profession and the public.
As painful as revisiting half a century of so-called scientific progress may be, it is unscientific and intellectually dishonest not to clearly admit what we do or don't know, with what certainty and caveats, and why. Empirical results can be useful, but they cannot have the same status as economic laws, or invalidate such laws.


In closing, some quotes from Austrian economist F.A. Hayek's 1974 Nobel Lecture, The Pretence of Knowledge which emphasizes this issue:

"It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences - an attempt which in our field may lead to outright error."

"(...) and I confess that I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false."

"To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm."

Posted by Julien on September 19, 2009. Permalink
Comments
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Gilles St-Paul must have read your post ;)
http://www.voxeu.org/index.php?q=node/3996

Excerpt :
"Any macroeconomic theory that, in the midst of the housing bubble, would have predicted a financial crisis two years ahead with certainty would have triggered, by virtue of speculation, an immediate stock market crash and a spiral of de-leveraging and de-intermediation which would have depressed investment and consumption. In other words, the crisis would have happened immediately, not in two years, thus invalidating the theory. Thus, most crises are by nature unforecastable."

Another interesting online debate on this issue (monism vs. dualism) can be found here :
http://rationalitelimitee.wordpress.com/2009/09/17/un-peu-de-reflexions-epistemologiques-1/
http://rationalitelimitee.wordpress.com/2009/09/17/un-peu-de-reflexions-epistemologiques-2/

Posted by: Gu Si Fang at September 20, 2009 11:15 PM

The term Economics comes from the Ancient Greek and is the social science that studies the production, distribution, and consumption of goods and services and economic forecasting is the process of making predictions about the economy as a whole or in part. and as to me this is the part of the whole economic science!

Posted by: AndreyM at September 21, 2009 12:43 AM
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