How to reform state of economics? Avoid Envying Physics…

Andrew Lo reflects on the state of economics and suggests what could be done to improve teaching in economics. He says the problem has been this economists fascination with Physics where things can be controlled in lab experiments and hence some superb research comes with accuracy etc.

Earlier economists were highly impressed with Physics and tried to model economics accordingly. Peter Boettke even said economics suffered big time because of Paul Samuelson:

So your view is that the profession took a wrong turn with Paul Samuelson?

That would be the argument, yes.

And do you agree with it?

Personally, yes I do. But there were a lot of things going on leading to this, one of which was that Samuelson was the brightest boy on the block, and when the brightest boy on the block goes in one direction, everyone else follows him. We’re in the midst of the Great Depression and World War II and this is a promise that we can avoid these kinds of problems. Then, the profession was really becoming professionalised, in a way that previously it wasn’t. People like John Stuart Mill were gentleman scholars. It wasn’t this whole professoriate, these departments and tenure and all those battles. Keynesian economics, post-World War II, dominated the entire profession. Everyone became a Keynesian and at the graduate, elite levels, it became a totally Samuelsonian project.

Samuelson had the intellectual entrepreneurship to write both the Principles ofEconomics textbook – which became the standard textbook for freshmen – and the standard graduate textbook. He dominated both ends of the economics profession. It’s a phenomenal intellectual achievement, independent of what you think about the content. I think Samuelson is worthy of intellectual attention, I just think he sent us in a wrong direction.

Coming back to Lo’s paper he tracks how things have moved over the years. He begins by picking some jokes on economics from his grad days. What was best joke according to him is also best according to this blog:

But the story I remember best was told by a graduating student who had worked as a research assistant for the head of the Council of Economic Advisors, a prestigious position that gave him unique insights into how economic policy was formulated. His story was about the glory days of the former Soviet Union, where the military would hold a parade each year to celebrate May Day, and leading the procession of tanks, missiles, and bazooka-bearing infantry marching proudly toward Red Square was a row of goose-stepping economists. One spectator turned to his companion and asked, “Comrade, why are there economists marching in this military parade?”, to which his friend replied, “Comrade, do you have any idea how much damage they can do?!”.

How and why the field became mathematicised to an extent that what was actually the servant became the master. Once again he thinks it all started from Paul Samuelson.

Despite these early critics, economics today is still dominated by a single paradigm of human behavior, a testament to the extraordinary achievements of one individual: Paul A. Samuelson. In 1947, Samuelson published his Ph.D. thesis titled Foundations of Economics Analysis, which might have seemed presumptuous—especially coming from a doctoral candidate—were it not for the fact that it did, indeed, become the foundations of modern economic analysis. In contrast to much of the economics literature at the time, which was often based on relatively informal discourse and diagrammatic exposition, Samuelson developed a formal mathematical framework for economic analysis that could be applied to a number of seemingly unrelated contexts.

He then proceeded to lay the foundations for what is now known as microeconomics, the subject of the first graduate-level course in every economics Ph.D. program today. Along the way, Samuelson also made major contributions to welfare economics, general equilibrium theory, comparative static analysis, and business-cycle theory, all in a single doctoral dissertation!

The problem was much of it was based on Physics:

If there is a theme to Samuelson’s thesis, it is the systematic application of scientific principles to economic analysis, much like the approach of modern physics. This was no coincidence. In Samuelson’s (1998, p. 1,376) fascinating account of the intellectual origins of his dissertation, he acknowledged the following:

Perhaps most relevant of all for the genesis of Foundations, Edwin Bidwell Wilson (1879–1964) was at Harvard. Wilson was the great Willard Gibbs’s last (and, essentially only) protégé at Yale. He was a mathematician, a mathematical physicist, a mathematical statistician, a mathematical economist, a polymath who had done first-class work in many fields of the natural and social sciences. I was perhaps his only disciple… I was vaccinated early to understand that economics and physics could share the same formal mathematical theorems (Euler’s theorem on homogeneous functions, Weierstrass’s theorems on constrained maxima, Jacobi determinant identities underlying Le Chatelier reactions, etc.), while still not resting on the same empirical foundations and certainties.

Much of the economics and finance literature since Foundations has followed Samuelson’s lead in attempting to deduce implications from certain postulates such as utility maximization, the absence of arbitrage, or the equalization of supply and demand. In fact, one of the most recent milestones in economics—rational expectations—is founded on a single postulate, around which a large and still-growing literature has developed.

I am ignoring the rest. But do read it as it has a fascinating account.

What are the suggestions for improvement. Maths should be there but should be used as a tool. More importantly people should appreciate other social sciences as well:

 

Rather than focusing solely on elegant theories, economics is at its Samuelsonian best when it marries rigorous theoretical and empirical analysis with practical challenges, using realistic assumptions regarding human cognitive abilities, institutional constraints, and transaction costs. Economists need not shy away from sophisticated mathematics, but technique should be the servant, not the master, of a greater purpose. And when such analysis leads to a fork in research paths, one leading to elegant theory under counterfactual assumptions and the other to messier but more realistic empirical or experimental results, the latter should be given at least as much priority as the former. In this respect, economics may benefit from the examples of anthropology, psychology, the cognitive sciences, and medicine, in which theories emerge inductively as well as deductively, motivated by empirical regularities and anomalies, and expeditiously discarded when they cannot explain the data.

This approach also has significant implications for how economics is taught. Unlike mathematics and physics, where gifted students can quickly develop intuition for some of the most fundamental concepts of the discipline, economics demands considerably greater institutional and historical context to achieve a comparable level of understanding. Although students of any introductory economics course can easily regurgitate the mathematics of supply and demand, until they witness the price-discovery process in action in a market that they care about, it is virtually impossible for them to fully appreciate both the power of the Marshallian cross as well as its many limitations in the face of trading costs, uncertainty, limited and asymmetric information, and institutional rigidities.

Instructors should challenge students and help build eco logic:

Therefore, one natural innovation is to teach economics not from an axiomatic and technique-oriented perspective, but by posing challenges that can only be addressed through economic logic. Instead of starting microeconomics with the consumer’s problem of maximizing utility subject to a budget constraint, begin by challenging students to predict the impact of a gasoline tax on the price of gasoline, or asking them to explain why diamonds are so much more expensive than water, despite the fact that the latter is critical for survival unlike the former. Instead of starting macroeconomics with national income accounts, begin with the question of how to measure and manage the wealth of nations, or why inflation can be so disruptive to economic growth. Without the proper institutional, political, and historical context in which to interpret economic models, constrained optimization methods and fixed-point existence proofs have much less meaning and are more likely to give rise to theory envy.

For Ph.D. students, gaining exposure to live economic environments before they begin writing dissertations should be a priority, and can be accomplished via industry and government internships or field work. By observing or participating in real economic activity in the domain of their likely field of specialization, students will develop a much deeper sense of purpose as they begin their research careers in economics.

Superb…But is the field going to change for better? Going by the responses I get talking to faculties, strong background in maths remains a priority for getting into economics program. It is like you are enrolling for a PhD/MSc/MA in math/stats and not economics…

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One Response to “How to reform state of economics? Avoid Envying Physics…”

  1. A conversation between Physicist and Economist on sustainable growth.. « Mostly Economics Says:

    […] There have been many criticisms on how econs try and make economics look and sound like Physics. This has led to a mad race for making turning all econ ideas into math formulas ignoring the social aspects of economics. Some like Andy Lo say to improve econ, we need to avoid envying Physics. […]

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