19 Apr 2009

What Good Are Economists?

That's what BusinessWeek asks in its cover article (via JWT). Here's an excerpt:
The rap on economists, only somewhat exaggerated, is that they are overconfident, unrealistic, and political. They claim a precision that neither their raw material nor their skill warrants. Too many assume that people behave like the mythical homo economicus, who is hyperrational and omniscient. And they take sides in quarrels that freeze the progress of research. Those few who defy the conventional wisdom are ignored.

Critics are scathing. Nassim Nicholas Taleb, the scholar of rare events who wrote Fooled by Randomness and The Black Swan, says: "We have to build a society that doesn't depend on forecasts by idiotic economists." Says Paul Wilmott, a quantitative finance expert: "Economists' models are just awful. They completely forget how important the human element is."

In the face of such withering criticism, it's tempting to ignore the whole profession. But that won't do.
No it won't.

Here are my comments on the article:
  • Most of it refers to macroeconomists (people who study aggregated, economy-wide effects), and they are notoriously inaccurate in their analysis, models, and forecasts. (Taleb is SO right.)
  • The trouble is that people WANT forecasts, so it's not really fair to complain when the forecasts are wrong.
  • As a microeconomist (someone who studies the behavior of individuals), I know that the mathematical models of homo-economicus are wrong, and I do not use them very much. Most of the time, I assume simple desires (to consume more or feel good) and work with obvious incentives (prices) to design mechanisms that use incentives to direct desires into "useful" outcomes (as opposed to failures, disasters, etc.)
  • As an example of how to do things RIGHT, consider my Real Estate Market Index [PDF], which indicated that the market was VERY VERY hot in June 2005. Even if the REMI was not "calling" the top of the market, someone looking at the data in 2006 would have seen that it had peaked -- even as prices continued to rise. I consider this result an example of useful macroeconomics built on microfoundations.
Bottom Line: Economists are useful but not for forecasting. Let them advise on incentives and evaluate policy effectiveness, and then let market forces determine what's "best" to do. (Oh, and shoot all the politicians with "free lunch" policies that promise all gain and no pain.)

1 comment:

  1. Any politician with a Party automagically inherits impossible optimism; worse, the ones there to hunt them can be territorial. (See, comic irony is alive!) So what were you going to shoot them? As for the economists; you can't be aware of editing scope and product of hired work, can you? Fannie Mae...man, that was kids with an interest in the field making report soup from bouillon. This is why we have citation data and abstracts; no free pass on critical thinking.

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