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Did you know that if you took all the economists in the world and laid them end to end…

… they still wouldn’t reach a conclusion???

Every time the government considers a policy to achieve some economic result, it seems that 1,000 different economist offer 1,500 different opinions as to how the government should go about achieving its goal.

Why is it that economists can never seem to agree about what to do??

And why does it seem like most of their forecasts don’t even end up coming close to what actually happens?

And it’s worse than just not being able to accurately forecast future events. Economists cannot even agree as to what it was that caused past events.

For example, Wikipedia describes The Great Depression as follows:

The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in 1930 after the passage of the United States' Smoot-Hawley Tariff bill (June 17), and lasted until the late 1930s or middle 1940s. It was the longest, most widespread, and deepest depression of the 20th century.

It’s been well over half a century since The Great Depression in the US ended, yet economists still do not agree as to what it was that ended The Depression. In particular, Frank G. Steindl, Professor of Economics Emeritus at Oklahoma State University, says

There are two prominent views about what ended the Great Depression. The most widely accepted one by far emphasizes U.S. entry into World War II, with its attendant government spending for armaments. According to this view, the U.S. economy in 1941, though approaching its potential output, remained well below it, so the war’s fiscal stimulus moved the economy completely out of the Depression. That the war ended the Depression is a view held not only by economists, but also by the public in general. The second view, in contrast, prominent particularly among economists, sees monetary expansion, which began in spring 1933, as the principal reason for its end.

Professor Steindl offers yet another explanation:

I maintain that forces inherent in the economy that promote productivity growth drove the recovery following the 1933 trough and moved the economy back to its trend.

Burton Folsom, Jr., a professor of history at Hillsdale College and author of FDR Goes to War, on the other hand, believes it was due to tax cuts by Congress “to encourage entrepreneurs to create jobs for the returning veterans.”

If economists can’t agree on what to do, if they can’t forecast future events, and they can’t even explain past events, why bother with economics and economists at all?

 

Economists Disagree Because They Adhere to Different Paradigms

How is it that two different groups of people can look at the exact same data and come up with diametrically opposed views as to what the data mean and/or what we should do about them?

An obvious example is how the US government should respond to the current economic situation. On one hand, the Democrats propose that we increase taxes to pay down the debt and increase government spending to stimulate the economy. On the other hand, the Republicans propose that the government do exactly the opposite: cut taxes to encourage people to increase spending and investments and cut government spending to decrease the debt.

Democrats and Republicans propose very different policy measures to this and other issues because they adhere to different paradigms. In The Structure of Scientific Revolutions, Thomas Kuhn defines paradigms as

…some accepted examples of actual scientific practice – examples which include law, theory, application, and instrumentation together – provide models from which spring particular coherent traditions of scientific research. P.10

A paradigm is similar to a mindset, which may be defined as

A fixed mental attitude or disposition that predetermines a person's responses to and interpretations of situations.

In other words, generally speaking, the Democrats (Keynesian economists) and Republicans (Neoclassical economists) each see the world from different perspectives, make different assumptions as to how things work, and interpret new information within the context of their current beliefs.

What’s interesting to me is how two diametrically opposed views of the world can not only exist at a point in time, but persist over time, even as new information becomes available. When I was thinking about this phenomenon, three different sets of ideas came to my mind.

The first set of ideas I thought about was inspired by Kuhn’s The Structure of Scientific Revolutions. First, Kuhn describes how people either buy into a paradigm or they don’t; that is, either you believe all the ideas associated with a paradigm or you don’t believe any of them – there’s no in-between.

When paradigms enter, as they must, into a debate about paradigm choice, their role is necessarily circular. Each group uses its own paradigm to argue in that paradigm’s defense.

The resulting circularity does not, of course, make the arguments wrong or even ineffectual. The man who premises a paradigm when arguing in its defense can nonetheless provide a clear exhibit of what scientific practice will be like for those who adopt the new view of nature. That exhibit can be immensely persuasive, often compellingly so. Yet, whatever its force, the status of the circular argument is only that of persuasion. It cannot be made logically or even probabilistically compelling for those who refuse to step in the circle. P.94

Kuhn also points out that people can adhere to a given paradigm, even though it may fail to explain certain phenomena:

…since no paradigm always solves all the problems it defines, and since no two paradigms leave all the same problems unsolved, paradigm debates always involve the question: Which problems is it more significant to have solved? Like the issue of competing standards, that question of values can be answered only in terms of criteria that lie outside of science altogether… p.110

Finally, Kuhn notes that when two opposing paradigms coexist over a period of time, it is often the case that one of the paradigms will eventually be found to be incorrect:

Concerned with scientific development, the historian then appears to have two main tasks. On the one hand, he must determine by what man and by what point in time each contemporary scientific fact, law, and theory was discovered or invented. On the other, he must describe and explain the congeries of error, myth, and superstition that have inhibited the more rapid accumulation of the constituents of the modern science text. P.2

Another idea that came to my mind in regard to paradigms, views of the world, or mindsets is how amazing it is that someone can be stuck with an incorrect mindset, and as new information comes along, that person can continue to misinterpret the new information in light of the erroneous mindset. In Normal Accidents: Living with High Risk Technologies, Charles Perrow describes this idea beautifully when discussing how a particular marine collision happened. In the case at issue, the crew of a Coast Guard cutter was correctly seeing what was going on with regard to an approaching cargo vessel, while the captain of the cutter was misinterpreting events. The crew didn’t correct the captain’s actions, because it assumed the captain knew what was happening. Yet in actuality, the captain was seeing things from his own erroneous standpoint, even as new information because available, which eventually led to the collision.

But what strikes me about this event [a collision in the Chesapeake Bay in October 1978 between a Coast Guard cutter training vessel and a large cargo ship] is how well it exemplifies the easy way in which we can construct an interpretation of an ambiguous situation, process new information in the light of that interpretation – thus making the situation conform to our expectations – and, when distracted by other duties, make a last minute “correction” that fits with the private reality that no one else sees. P.217

Finally, in regard to mindsets, I thought about the idea, studied at length by psychologists, about how people with a certain view of the world will commonly seek out information that confirms that view, while simultaneously disregarding or discrediting information that opposes or refutes it. As Jonathan Haidt in The Righteous Mind: Why Good People Are Divided by Politics and Religion describes it,

Psychologists now have file cabinets full of findings on “motivated reasoning,” showing the many tricks people use to reach the conclusions they want to reach…

If people can literally see what they want to see – given a bit of ambiguity – is it any wonder that scientific studies often fail to persuade the general public? Scientists are really good at finding flaws in studies that contradict their own views, but it sometimes happens that evidence accumulates across many studies to the point where scientists must change their minds. I’ve seen this happen in my colleagues (and myself) many times, and it’s part of the accountability system of science – you’d look foolish clinging to discredited theories. But for nonscientists, there is no such thing as a study you must believe. It’s always possible to question the methods, find an alternative interpretation of the data, or, if all else fails, question the honesty or ideology of the researchers. Pp.84-5.

In short, economists will never agree because they adhere to different paradigms, which lead them to maintain certain beliefs about how the economy works, interpret economic information in light of those priors, and prescribe different policy measures consistent with their models.

 

Economists Can’t Forecast Future Events Accurately or Explain Past Events Because the Economy Is a Complex Adaptive System

How can any of the paradigms used by economists maintain credibility, given that none of them seem to be able to predict future events accurately?

The answer is that it’s not really the fault of economists that none of their models can accurately predict the future. The problem is that the economy is a complex adaptive system. Loosely speaking, a complex adaptive system (CAS) is a system of entities that interact with one another and react and adapt to changes in the environment. What this means is that the environment is constantly changing as entities constantly act and react.

An interesting feature of CASs is the fact that when the environment changes, it causes cascades of changes throughout the environment as various entities react to the cascading changes. What this means is that small (large) changes in the environment can end up having large (small) impacts on the economy. That is, the ultimate impact of any change is nonlinear.

Because there are so many different entities in the economy, all acting and reacting to changes in the environment, each with potentially nonlinear impacts, the ultimate impact of any particular change is inherently unpredictable.

As if this unpredictability weren’t enough to stymie economists’ predictions, any economic policy undertaken by government takes time to take effect. In other words, there are lags in the economy with respect to actions taken by government. And as time passes, independently of any action taken by the government, the entities in the economy are evolving with other (non-government-induced) changes in the environment. So, by the time any government policy is able to take effect, the environment has changed. By its very nature, then, government is trying to hit a moving target.

If you combine the time lags in government policy with the inherent unpredictability of future environments, what you get are notoriously unpredictable forecasts by economists.

This combination of time lags and inherent unpredictability of future environments also means economists cannot easily prove or disprove a theory. In science, theories are normally proved or disproved by creating a controlled environment and modifying variables affecting a particular experiment one at a time to see what happens. In such an environment in which all relevant variables are accounted for, one is able to prove that under specific circumstances, a specific action leads to a certain reaction.

The economy is becoming increasingly complex over time as the world globalizes and more other entities are able to affect any one entity’s environment. As a result, there are increasing numbers of different variables that have the potential to affect the economy, each in nonlinear ways, that economists cannot possibly account for all of them in their models and predictions. When a theory does not end up working out in the real world as predicted, it is not necessarily that the theory, as stated, was wrong. Rather, it was usually that some unaccounted for variable(s) ended up having an impact on the situation, which changed the ultimate outcome from that which was predicted. The fact that the two outcomes did not coincide, however, does not disprove the theory, since it wasn’t the original theory that ended up being tested.

In particular, the Democrats and the Republicans had very different views of what should have been done to address the 2008 financial crisis. However, now that time has passed, we will never know what would have worked best to fix the crisis, because the conditions that defined the economy at that time have changed. So even if Romney wins the election, comes in, and, say, cuts spending and taxes in 2013, and the economy picks up soon afterward, that wouldn’t PROVE that that’s what should have been done in 2008. After all, the state of the world in 2013 will be different from the state of the economy in 2008, and whatever Romney does will be acting on the 2013 economy, which would fail to prove anything about the 2008 economy.

The plethora of variables in the environment, together with the nonlinear impact potential of each variable, also means that it is difficult to recreate events exactly or to look at past events and tell which of the variables were actually important in determining the ultimate outcome of some event. Hence the disagreement about what ended The Great Depression.

 

Regardless, Economic Theory Is Still Useful

So if economists can’t agree on what to do, if they can’t forecast future events, and they can’t even explain past events, why bother with economics and economists at all?

Arguably, at least some economic predictions would work in a vacuum, because many economic theories do work. (A List of the Top 50 Economic Theories by Donald Marron can be found here.)

So it’s not necessarily the theories that are wrong (though some surely are -- this reminds me of John Wanamaker's famous quote "Half the money I spend on advertising is wasted; the trouble is I don't know which half"), but the fact that after they are implemented, other things often “get in the way.” So even if economics doesn’t get us all the way to where we’re going, it can usually point us in the right direction or otherwise set us on the right path. And if the unexpected forces end up being relatively small economic theory can usually get us most of the way to where we’re going.

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