Philip Mirowski has a must-read article in The Hedgehog Review about 'The Great Mortification': the soul-searching (such as it is) that the economics profession has undergone since 2007. Two key points in Mirowski's article are really important--and are relevant to most, if not all, intellectual disciplines. The first is "This Is What Happens When You Banish History and Philosophy":
...the task is to recount these events as a sequence of otherwise avoidable tragedies, the first of which must be conceded to have been the exile of history and philosophy from any place within the contemporary economic orthodoxy. After a brief flirtation in the 1960s and 1970s, the grandees of the profession took it upon themselves to express their disdain and scorn for the types of self-reflection practiced by "methodologists" and historians of economics and to go out of their way to prevent those so inclined from occupying any tenured foothold in reputable economics departments.
It was perhaps no coincidence that history and philosophy were the areas where one found the greatest concentrations of skeptics concerning the shape and substance of the postwar American economic orthodoxy.
Believe it or not, those stupid fucking natural history facts do matter:
....biologists aren't only trying to derive general principles, they're also trying to figure out how organism- or system-specific processes work.
To use a very macabre example, we are interested in a how a gun fires a bullet--and in a controlled environment, we can estimate very precisely how that bullet will travel. But, a biologist is also faced with the task of trying to figure out what happened on the grassy knoll in Dallas. The study of ballistics is necessary, but not sufficient. At the risk of completely tasteless overkill, does anyone view September 11th primarily (or even entirely) as a structural engineering problem? Those stupid natural history facts matter too. Understanding and predicting particular events also requires a knowledge of phenomena that can not be generalized and reduced to simple general theory.
The other key point is that, just as some ecologists and evolutionary biologists declared during the 1970s and 1980s that those disciplines suffered from 'physics envy', so too economics:
As I have shown elsewhere in detail, neoclassical economics was born of a crude attempt to directly imitate physics in the 1870s, and American orthodoxy was the product of further waves of physicists cascading over into economics in the Great Depression and WWII....
Actually, it is understood among the cognoscenti that physicists have again been tumbling head over heels into economics since the 1980s, as their own field experienced severe contraction at the cessation of the Cold War. And where did most of them end up? Why, in the banks, of course, inventing all those ultra-complex models for estimating and parceling out risk. Some troubled to attain some formal degree in economics, while others felt it superfluous to their career paths. In any event, the exodus of natural scientists into economics was one of the (minor) determinants of the crisis itself--without "rocket scientists" and "quants," it would have been a lot harder for banks and hedge funds to bamboozle all those gullible investors. So much for the bracing regimen of a background in the natural sciences.
If anything, responses to critics that tended to pontificate upon the nature of "science" were even more baffling than the original calls for deliverance through natural science in the first place. Economists were poorly placed to lecture others on the scientific method; although they trafficked in mathematical models, statistics, and even "experimentation," their practices and standards barely resembled those found in physics or biology or astronomy. Fundamental constants or structural invariants were notable by their absence. Indeed, one would be hard pressed to find an experimental refutation of any orthodox neoclassical proposition in the last four decades, so appeals to Popper were more ceremonial than substantial. Of course, sometimes the natural sciences encountered something commensurable to a crisis in their own fields of endeavor--think of dark matter and dark energy, or the quantum breakdown of causality in the 1920s--but they didn't respond by evasive maneuvers and suppressing its consideration, as did the economists.
Or as Yves Smith has noted, economics needs to realize that it is a social science, as much a mathematical one. To hammer the point further, I want to end with something Barry Eichengreen wrote:
The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy.
In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.
Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.
Unlike some who denigrate economics, I'm not glad it failed--it needs to get things right next time. But it needs to spend less time trying to glimpse the Economic Godhead and more time explaining concrete economic phenomena, and that will require approaches in addition to abstract mathematical models.
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Speaking of physics envy, there is the instant classic Warning: Physics Envy May be Hazardous to Your Wealth! by Andrew W. Lo and Mark T. Mueller. (Google pointed me to the Social Science Research Network, but I first saw that paper on the arXiv.) Well worth a read.
One of my big regrets as an econ major was that I didn't take the class titled The History of Economic Thought. I was on the BS track taking the modeling classes and I didn't have the units to spare. Even if I had, I doubt that I would have recognized its importance until it was too late.
What I didn't then was that the field doesn't operate like a healthy science (social or otherwise). People often really don't understand what schools of thought outside their own really say. Other disciplines have created solid unifying frameworks over the past few generations. While economists broadly agree about a lot of things, the foundations are still so weak that as soon as something shakes up a few of the models, everybody goes back to debating the meaning of The Holy Works of economists from the early 20th century.
Imagine if you heard a physicist say, "I'm rereading Newton's Principia to see if there are any insights I missed that might help me with this problem." Seriously? You have to go that far back?
"Actually, it is understood among the cognoscenti that physicists have again been tumbling head over heels into economics since the 1980s, as their own field experienced severe contraction at the cessation of the Cold War."
I wonder if there is any substantive evidence to that effect. I work in an area of the military-industrial complex with a lot of physical scientists (including myself) who couldn't find work in their own fields and ended up here. I am not aware of any of them who left this field to go work in economics.
Mark P,
As a graduate student in physics a few years ago (pre-collapse), I attended a colloquium given by a quant with one of the big firms who talked enthusiastically about the work and opportunities for physicists on wall street. Also, anecdotally, I've had peers who left physics to become consultants, actuaries, and accountants. (Not wall street per se but a similar change in work I think.)
As for the impact of physics/math in economics, I tend to think that a lot of the complicated financial shenanigans are a result of giving good analytic thinkers a small problem. "Maximize this number says the boss." "Okay," says the ex-physicist and comes up with a way to do so. It works great for a while but no one is being paid to look at the big or long-term picture, much less to make ethical considerations. That sort of thing should be done by macro-economists and policy-makers, but there I think the system is so complicated that no one can claim a complete analysis and people seem swayed by political/faith sects. How often have you heard conservatives say that "free markets are always the most efficient" and how meaningless is that statement?
Josh: The rise in financial shenanigans is correlated with the rise of quants on Wall Street, but I think the real problem was that almost nobody--not the quants, and certainly not their bosses--understood the limitations of a physics background in this context.
Having a physics background is good for solving problems that have one or two dominant effects. You either write the equations so that other effects are neglected entirely, or take what is called a "perturbation theory" approach where you expand the equations in powers of some dimensionless ratio which measures the relative importance of some minor effect compared with the dominant effects. There is a large class of problems for which perturbation theory works. But sometimes the procedure breaks down, either because the small effect is attached to a boundary condition (e.g., the Navier-Stokes equations, which is why fluid turbulence is a hard problem) or because the small effect is actually not so small (e.g., particle-particle coupling in QCD).
The problem with applying physics intuition to economics is that most of the problems that arise in economics are in one of the latter two categories. For instance, it is common in trading algorithms and options pricing to assume that asset price movements have a Gaussian distribution. If you don't know any better, that is a superficially reasonable approximation, because the Central Limit Theorem tells you that an ensemble of arbitrary probability distributions will tend toward a Gaussian distribution as the size of the ensemble increases without bound. But the evidence (due to Benoit Mandelbrot) was that asset price movements have a power law distribution, not a Gaussian distribution, and the effect of that tail turned out to be much more important than anybody on Wall Street had suspected. Also, the Central Limit Theorem doesn't tell you how rapidly your ensemble will converge to a Gaussian distribution--you may need a much bigger ensemble than you think.
Eric,
I don't disagree with the bulk of what you say, except that I don't see that a physics background has anything in particular to do with the problems you cite. The Navier-Stokes eq. is a physics equation. QCD is a physics theory. Physicists study how to handle these things. Assuming a Gaussian is a common approach but a competent physicist should be aware that it is an approximation and it should be checked against data.
I guess what I'm saying is: people with physics training may have made these mistakes on Wall Street, but what other background would have prevented it? Is it that incoming physicists assumed economics problems were inherently simple compared to "real" physics? I know some economists foresaw problems but my impression is that few were out there screaming about the hubris of misapplied perturbation theory.
I'm not a financial expert but my intuition tells me that rapid, sustained growth in housing prices driven by speculation is probably an unstable bubble; that complicated, unregulated credit-default swaps where everyone is betting more money than they have are dangerous; that sketchy book-keeping where companies hide or overvalue bad assets is a bad thing. Did ex-physicists think they had solved the whole system and disabused us of these concerns? Or did they think, "Hey, this works, I'm making money, and that's my job now."
Maybe I'm not sufficiently familiar with the details or maybe I'm just being defensive for my field, but it seems strange to me that this is cast as an anti-physics backlash and not another case of the wall street mindset exploiting new tools for short-term gain while exporting risk and cost to society at large.
Archetypical of academiaâs duplicitous principal is the economic professor who in the classroom touts the value of a reward based free market economy while in personal life continually aspires for tenure. Proliferating the morally depraved precept to imitate, do what I say, not what I do. Whereas imitation like biological cloning creates a declining impetus wherein the maladies of age come sooner than later, a copy of a copy of a copy. Now this situation is ok if your intent is to create replacement parts, but not if the goal is to ameliorate.
You all are on the right tract by encouraging the balance of diversity as adverse to academiaâs model of compartmentalization with no correlating authority. Which in itself is currently being commandeered by the corporate quest for profit. What happens when a system of education inculcates the Hindu/Arabic number system with a subsequent open ended (infinity) application designed specifically to facilitate commerce through mathematical analysis, then augmented to assist engineering ...You create a cultural mindset of consumerism and doctrines with an allegiance dedicated to profit, such as; The Law of Supply and Demand, The Law of Diminished Return, The Law of Accelerating Returns, The Law of Increasing Cost and The Law of Increasing Opportunity Cost, etc. etc... all arbitrary rules of thumb expressed as authoritative.
There is another esoteric application that is predicated on a zero sum game with balance as its correlating authority and culminating with a magnitude of 9. Whose purpose is bio - behavioral modeling. Now why do you think your education is lacking this knowledge ⦠Nietzsche âAll things are subject to interpretation whichever interpretation prevails at a given time is a function of power and not truthâ
Not many went into economics. They went into quantitative finance. Perhaps the most prominent physicist who did so was Emanuel Derman. His autobiography My Life as a Quant goes into great detail regarding his life, from a sputtering start as a high energy theorist--his thesis proposed the famed electroweak test carried out by Prescott-Taylor at SLAC, yet he couldn't get tenure???--to his spectacular success as a quant.
It's not meaningless. In fact, in certain extremely hypothetical ideal senses it's even true. We don't live in a certain extremely hypothetical ideal world, though, and this fact gets conveniently ignored by people who are paid to not know any better.
That said, conservatives do not believe in free markets whatsoever, except when convenient for their purposes. Much of modern Wall Street consists of state-guaranteed market inefficiencies, the better to make a fortune. In other words, your statement is not just meaningful, it's meaningfully false.
One historical irony here is that Fischer Black was considered an extreme oddity on Wall Street. Why? Because he actually believed in equilibrium pricing! I mean, everyone knew equilibrium pricing was for suckers only.
Josh: Don't get me wrong, I'm a practicing physicist myself. The blame properly rests with the C-suite officers of these Wall Street firms; as Brad DeLong likes to say, the Cossacks work for the Czar. They should have seen what was coming; anybody with a background in high school math who looked at the data should have been able to figure it out. But there is a definite culture clash between physics and finance, one which goes beyond what I posted above.
To amplify my earlier point, most financial problems are hard problems. Once you go beyond linear/perturbation analysis, there are other techniques you have to resort to. But the trick that works in one case may not work in other cases, so you learn the tricks that apply to the sorts of problems you study. For example, I wouldn't have a clue how to do a QCD lattice calculation because that's not my field. If I were a Wall Street quant trying to tackle a problem with fluid dynamics tricks (with which I am more familiar), I might not know until late in the game that QCD is the better approach. Conversely, someone with a QCD background might run into trouble on a problem which calls for a fluid dynamics approach.
Compounding this is the important difference between academic and corporate cultures which is captured in the following joke: There are two things you need to do to succeed in the corporate world, the first of which is, "Don't tell everything you know." In the academic world, I know what my rivals in Berkeley or Stockholm or Tokyo are doing because I read their papers and see their conference presentations. So if one of those rivals has discovered that the spherical cow approximation isn't valid for this particular problem, I don't have to waste my time figuring out that this cow isn't spherical. Not so in the corporate world; the quants at Goldman Sachs have to discover independently from those at JP Morgan, as well as from every other Wall Street/City of London shop out there, whether they can approximate any particular cow as being spherical, and the only way to do so is to test their models in the real world. The models worked fine on test data from the recent past (i.e., early to mid 00s). Since the bosses were pleased with the money the quants were earning for the firm, nobody thought to try things out on a wider data set such as, say, real estate prices in California or New England in the 1989-1995 time frame.
Eric,
I think your analysis is perfectly fair. I don't have the direct experience to say for certain, but the idea of different cultures is plausible to me. I can also imagine physicists entering a new field underestimating the complexities of the broader picture or ignoring some established wisdom. I just want to clarify that I don't think this is a "physics" mindset as opposed to some other profitable approach. Arrogance or naivete perhaps, but not some statement about the limits of physics. Physics already has those limits within itself and you can't get around them by going to some other science.
william,
I meant meaningless primarily in the sense that those who spout this kind of line have no idea what they are talking about. Moreover, the "efficiency" in my example is, as I understand it, the Pareto efficiency, which is quite different from the normal (but still ambiguous) uses of the word. Pareto efficiency is not obviously a goal that we should have as a society. I'm also dubious that "free market" has any rigorous definition that does not apply to either all markets or none.
"Since the bosses were pleased with the money the quants were earning for the firm, nobody thought to try things out on a wider data set such as, say, real estate prices in California or New England in the 1989-1995 time frame."
I think this illustrates a pretty important point on how physics is done, which is that by and large we try to find the limits of our models. While the basic laws of physics apply pretty broadly, to solve any realistic problem you need to do many approximations which limit the scope of the resulting model. It's unavoidable, but it's usually fine so long as you can figure out what those limits are and don't try to apply your model where it's not applicable (i.e. don't try to do newtonian mechanics at speeds close to c).
So I don't think the problem is so much that economics is trying to be like physics, the problem is that it's trying to be a caricature of physics in popular culture, where a few simple laws can lead to a model which supposedly applies to everything. In reality there may be some underlying laws, but the actual models that can be used to predict real systems are more limited and approximate.
Or maybe it's just a harder system. I forget the exact quote by Feynman but it was to the effect of "physicists are successful because we solve the hydrogen atom, the helium atom, and stop there".
Using linear models in a world where all the real actors use the binary "greed" or "fear" as their main explanation of what is going on, seems like a very optimistic aproximation. Almost like using Newton close to c, as mentioned above.
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