If you haven’t read Paul Krugman’s recent NY Times Magazine article “How Did Economists Get It So Wrong?“, I recommend it highly. One of the interesting things about Krugman is that he has been talking about this issue for over a decade. In a 1996 lecture, he presented an argument that economics needs to learn from evolutionary biology:
….consider the question of whether and how monetary policy has real effects. In the end this comes down to whether prices are sticky in nominal terms. In my view there is overwhelming evidence that they are. But many economists reject such evidence on principle: a rational price-setter ought not to have money illusion, therefore it is bad economics to assume that they do. If neo-Keynesians like me suggest that a bit of bounded rationality would do the trick, the answer is that bounded rationality is too open-ended a concept, and can be used to rationalize too many different behaviors.
And yet in evolution the idea that there are limits to the precision of maximization is adopted cheerfully. When a bird sees a predator, it issues a warning cry that puts itself at risk but may save its neighbors; the reason this behavior “works”, we believe, is that many of those neighbors are likely to be relatives, and thus the bird may enhance its “inclusive fitness”. But why doesn’t the bird issue a warning only its relatives can hear? Well, we just suppose that isn’t possible.
In short, I believe that economics would be a more productive field if we learned something important from evolutionists: that models are metaphors, and that we should use them, not the other way around.
While I have some problems with Krugman’s article regarding modeling*, it’s an interesting point of view. Obviously, as an evolutionary biologist, I’m flattered. Yet, in the 1996 article, he overemphasizes the role of theory in the successes of evolutionary biology. Sure, the openess of evolutionary biologists to the concept of non-optimality is an improvement over the dogmatic insistence that people behave rationally (optimally). But Krugman downplays what has led to the success of evolutionary biology: the triumph of data. In fact, there was a period where evolution was disparaged by other biologists because it was viewed as “just so stories”–tales with no data to support them.
On the old site, I joked several times that the difference between biologists and economists is that when theory and data collide, a biologist claims the theory is wrong, whereas an economist proclaims that the data are wrong (this resulted in several angry emails). But consider what Krugman writes in his NY Times article:
By the 1980s, however, even this severely limited acceptance of the idea that recessions are bad things had been rejected by many freshwater economists. Instead, the new leaders of the movement, especially Edward Prescott, who was then at the University of Minnesota (you can see where the freshwater moniker comes from), argued that price fluctuations and changes in demand actually had nothing to do with the business cycle. Rather, the business cycle reflects fluctuations in the rate of technological progress, which are amplified by the rational response of workers, who voluntarily work more when the environment is favorable and less when it’s unfavorable. Unemployment is a deliberate decision by workers to take time off.
Put baldly like that, this theory sounds foolish — was the Great Depression really the Great Vacation? And to be honest, I think it really is silly. But the basic premise of Prescott’s “real business cycle” theory was embedded in ingeniously constructed mathematical models, which were mapped onto real data using sophisticated statistical techniques, and the theory came to dominate the teaching of macroeconomics in many university departments. In 2004, reflecting the theory’s influence, Prescott shared a Nobel with Finn Kydland of Carnegie Mellon University.
Sweet Baby Intelligent Designer, “[u]nemployment is a deliberate decision by workers to take time off”? That doesn’t even pass the smell test. Has Prescott ever been in the non-academic job market?
Ok, um, has he ever read about laid off employees? Again, Krugman:
Can anyone seriously claim that we’ve lost 6.7 million jobs because fewer Americans want to work? But it was inevitable that freshwater economists would find themselves trapped in this cul-de-sac: if you start from the assumption that people are perfectly rational and markets are perfectly efficient, you have to conclude that unemployment is voluntary and recessions are desirable.
What seems missing is some good economic ‘natural history’–that is, data. Here’s what Krugman says about Steven Jay Gould:
What I encountered were quite a few references to Stephen Jay Gould, hardly any to other evolutionary theorists. Now it is not very hard to find out, if you spend a little while reading in evolution, that Gould is the John Kenneth Galbraith of his subject. That is, he is a wonderful writer who is bevolved by literary intellectuals and lionized by the media because he does not use algebra or difficult jargon. Unfortunately, it appears that he avoids these sins not because he has transcended his colleagues but because he does does not seem to understand what they have to say; and his own descriptions of what the field is about – not just the answers, but even the questions – are consistently misleading. His impressive literary and historical erudition makes his work seem profound to most readers, but informed readers eventually conclude that there’s no there there. (And yes, there is some resentment of his fame: in the field the unjustly famous theory of “punctuated equilibrium”, in which Gould and Niles Eldredge asserted that evolution proceeds not steadily but in short bursts of rapid change, is known as “evolution by jerks”).
What is rare in the evolutionary economics literature, at least as far as I can tell, is references to the theorists the practitioners themselves regard as great men – to people like George Williams, William Hamilton, or John Maynard Smith. This is serious, because if you think that Gould’s ideas represent the cutting edge of evolutionary theory (as I myself did until about a year and a half ago), you have an almost completely misguided view of where the field is and even of what the issues are.
This is unfair to Gould and Eldredge: the reason punk eek is no longer widely accepted** (although neither is it uniformly disparaged) is because it was confronted with the fossil record and found wanting. This is a point Barry Eichengreen makes:
The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost.
But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.
The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty.
The one problem I find with Krugman’s recent article is the lack of emphasis on the need to brutally confront theory with data. There is one sentence at the end, “they’ll have to do their best to incorporate the realities of finance into macroeconomics”–but I think a lot more will have to be done than that.
*Mostly that he ignores population genetics, and, instead, focuses on behavioral models.
**Some, unfairly in my opinion, also thought Gould was a pompous ass. That probably didn’t help either.