Saturday, July 21, 2012

Discarding failed ideas

There are three types of questions in economics: (1) is it true? (2) is it efficient? and (3) is it good? The first question corresponds to the scientific side of the field. When we are curious about things like the relationship between unemployment and inflation or the determinants of international trade, we are solely concerned with objective, empirical realities.

The second question corresponds to the engineering side of the field. When economists are engaged in policy analysis or market design, we focus on maximizing some quantity, like utility or output, while minimizing cost.

Finally, the third question corresponds to the moral philosophy side of the field. We may understand that a relationship exists in the world and may agree on policies that will maximize or minimize one or more of the variables. But we still must grapple with the desirability of a given outcome. For example, what constitutes a just economy? And when is efficiency a worthy goal?

Consider economic inequality. There is broad agreement that economic inequality has increased throughout the developed world since the 1970s. There is also an understanding that certain policies, such as progressive taxation, can mitigate economic inequality, and that policymakers can nudge an economy in one direction or another. But economists, and the public more generally, are far from in agreement on how much inequality is acceptable in a good society.*

I use this framework when thinking about whether or not economics should be considered a science. Personally, I think that that is the wrong question. Economics contains scientific questions and those questions can and should be approached scientifically. It is in this regard that I think we have not always succeeded.

Consider this piece by Noah Smith about the use of falsification in macroeconomics:

“If smart people don't agree, it may because they are waiting for new evidence or because they don't understand each other's math. But if enough time passes and people are still having the same arguments they had a hundred years ago - as is exactly the case in macro today - then we have to conclude that very little is being accomplished in the field. The creation of new theories does not represent scientific progress until it is matched by the rejection of failed alternative theories...

So as things stand, macro is mostly a "science" without falsification. In other words, it is barely a science at all. Microeconomists know this. The educated public knows this. And that is why the prestige of the macro field is falling. The solution is for macroeconomists to A) admit their ignorance more often (see this Mankiw article and this Cochrane article for good examples of how to do this), and B) search for better ways to falsify macro theories in a convincing way.”

The goal of science is generating increasingly precise approximations of reality. This can only happen by pruning away the ideas that don’t work.

To a certain extent, this is a function of the data economists have to work with, especially in macroeconomics. We can’t do experiments at that level and economic systems are fantastically complex. Thus we should expect economics (and indeed most social sciences) to progress slowly. But beyond this, we need to develop a culture of falsification, where ideas that are demonstrated not to be true are discarded, no matter what.

If you’re theory tells you that what you’re seeing happen cannot happen, then you need a better theory. Until then, there’s no progress to be had.

*In his book "Adam's Fallacy," Duncan Foley doubts that the moral questions can really be severed from the efficiency questions in economics. Specifically, he argues that there is a fallacy within Adam Smith's "The Wealth of Nations": the idea that we can separate an economic sphere of life, where self-interested behavior leads to the collective good, from the social sphere of life, where purely self-interested behavior is seen as immoral.

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