What’s wrong with economics? Part 1: The disorganisation of economics

These days economists have a bad reputation. And not only because almost all of their forecasts are wrong. They failed to predict both the financial crisis and the Euro crisis; indeed, most of them did not even have a vague hunch that they were under way. Moreover, they only recognised other developments, such as the rise of emerging markets, long after they had started.

It is not only their forecasts that are not up-to-scratch; their analyses of the causes and consequences of economic developments are also contradictory. A neutral observer could rapidly come to the conclusion that economics is like a bag full of treasures, which interest groups or representatives of specific ideologies can dip into in order to pull out arguments that suit their purposes. And it has nothing to do with objective science.

This negative impression is reinforced by the role assigned to economists by the modern media – the role of the “party pooper”. When current affairs programmes require a gloomy expert to issue credible warnings that things are going to come to a nasty end, they go looking for an economist. If a TV talk show needs a finger-wagging, cautionary and completely humourless participant, they generally invite an economist. And if they decide they want to feature two people in a talk show accusing each other of being completely incompetent, they then invite two economists from different camps.

But why is the quality of economics so bad? Is the state of economics really so pitiful? Or is the general public being presented with a distorted picture of reality?

Why did nobody see it coming?”, asked Queen Elisabeth II in a speech to the London School of Economics on November 5, 2008, shortly after the financial markets had collapsed in what was to become the greatest economic crisis of the period after World War II. This remark has been quoted several times since then to describe the failure of economics. Actually, Queen Elisabeth’s observation was not quite accurate. While she was right for most mainstream economists, who were not aware that a crisis was looming, a few economists had tried to sound the alarm bells before the crisis broke. However, they were ignored by their colleagues, politicians, managers and the general public.

Economists such as Robert Shiller or Paul Krugman repeatedly referred to the speculation bubble that was developing on the US real estate market in the years before the crisis escalated, warning of its consequences. Drawing on the thinking of Benoit Mandelbrot, Nassim N. Taleb developed his “black swan” theory dealing with extreme events – such as the financial market shock – before the financial crisis. Already at the beginning of the 90s, researchers described the mechanisms of a financial crisis, anticipating future events. In 1992 Graciela Chichilnisky developed the term “endogenous uncertainty“, which describes how complex systems generate systematic risks from within themselves. Hyman Minsky also showed how financial systems destabilize themselves after a long period of stability in his paper “The Financial Instability Hypothesis” in 1992. This is because the actors within a financial system start to see themselves and their business environment as positive. In 1998 the so-called “Minsky Moment” was named after this scholar, the moment at which previously stable financial systems tip into instability.

Some decades ago, economics was a highly respected science; its leading thinkers were admired as outstanding personalities. Adam Smith, John Maynard Keynes, Nikolai Kondratjew, Friedrich von Hajek, Joseph Schumpeter and many more – they were great minds that fundamentally helped us to understand the economy and society better. So what caused this unprecedented collapse of the economic sciences in the eyes of the public?

In my opinion, the questionable image of economics today was caused by four main factors:

  1. the lack of exchange with other disciplines and with business practitioners;
  2. the high concentration of scientific enterprise on the top American universities;
  3. a deterministic view of the world that fails to deal with the realities of complex economies
  4. the unnecessary discord between economists on economic policy issues;
  5. the distorted media attention paid to economic statements.

Economics, the economy in practice and the rest of science

The mathematisation of economics has been frequently blamed for the misery of this science. It started in the 1950s, driven by a growing pressure to match the (seemingly) precise natural sciences. The feeling was that economics needed to a system of formulae to be recognised as a reputable science. And, indeed, there were good reasons for applying mathematics, in particular as the use of mathematical formulae can enhance logical thinking. A side effect of mathematisation, however, was a growing dissociation with the other social sciences, as they were now suddenly considered to be imprecise. Anything that could not be converted into a mathematical formula was no longer taken seriously by economists. But they were making a crucial error – the creation of this formal system had become more important than the contents and, as a result, economics was distancing itself inexorably from reality. This, in turn, enlarged the gap between research and economic practice, isolating the scientists in an ivory tower.

Milton Friedman claimed that economic models could contain unrealistic economic assumptions, providing they produced meaningful results – a claim that has turned out to be particularly fatal. It has served as a perfect excuse for all types of nonsense, enabling many economists to justify practising their science as “l’art pour l’art”.

In the meantime this development has been partly reversed. The advent of behavioural finance and experimental economics has introduced psychology into economic research. Nevertheless, most economists continue to turn their nose up at other disciplines, such as economic sociology, although these could very possibly advance their understanding of concrete economic problems, such as the last financial crisis.

There is also considerable scope for improvement with regard to sharing views with business practitioners. Contact between science and business today mainly occurs when interest groups seek an economist – and by definition they go looking for one that supports their positions. The majority of scientists conspicuously lack interest in discussing with practitioners, unless of course they hope to find a sponsor prepared to provide research funds. It goes without saying that this situation is not particularly conducive to objective and innovative science.

The American men’s club of leading economists

When the Nobel prize for economics is awarded every year, we may not be completely certain as to who is going to be the lucky winner; however one prediction has been fairly reliable to date. The winner is always an elderly Caucasian gentleman, who works or has previously worked at one of the top American universities. The French winner in 2014 – Jean Tirole – is no exception to this rule: He received his Ph.D. degree from the MIT in 1981 and worked there as a professor from 1984-91.

Economics is completely dominated by researchers from a handful of American universities – a situation that is unmatched in any other science. Strangely, this dominance does not only apply to the mainstream. Even the most prominent original thinkers who break with the mainstream (e.g. Steven D. Levitt with Freakonomics) are employed by leading US institutions.

This development is partly because the definition of success in academia today is a scientist’s ability to produce articles that are published in renowned scientific journals and are cited frequently by other researchers. Articles are selected according to a so-called review process, which involves established scientists evaluating submissions and, if necessary, requesting revisions. Thus, there seems to be only one recipe for success for a career in science: An ambitious scientist has to a) publish articles on topics that have already been researched relatively broadly, because if not there is a risk that the author will not find a reviewer and will not be cited sufficiently. Secondly, b) the article has to be formulated in a way that it is approved by the potential reviewers. As a rule, these reviewers are established economics professors; so the author increases his chances of success by staying as close as possible to the economic mainstream that has already been published. There is little point in risking rejection with new ideas. “No experiments” is, however, clearly not a suitable motto for researchers. On the other hand, the blinkered specialists, who rehash old contents to present them in a different packaging, are the winners of this game.

Only researchers in established positions can afford to produce articles with non-mainstream contents, because their articles are published regardless of what they have written. These are generally only researchers from the top US universities. It is therefore logical that US educational institutions dominate both the mainstream and non-mainstream.

Another factor in economics that stifles innovation is the fact that many universities and research institutions have become “Kafkaesque” systems, hampered by meaningless bureaucratic rituals. Many scientists aspire to a professorship in order to enjoy the privileges of being a civil servant. When they subsequently have the power to decide what can be considered scientific progress and what not, it is perfectly clear that they are not going to come up with anything original. Interdisciplinary research projects (i.e. the exchange of views between different scientific disciplines) is currently considered to be a career killer, because interdisciplinary work complicates clear classification into discipline-specific thought patterns. This once again paves the way for the blinkered specialists, because they are so easy to classify.

The outcome is that progress can only involve ideas that comply with previous thought patterns, and not ideas that are new and innovative. The exceptions are, once again, a handful of elite English-speaking universities that cultivate a relatively open culture of debate, enabling them to foster creative lateral thinkers. This is also a reason why the mainstream think-tanks spawn the progressive non-mainstream thinkers.

To be continued on Wednesday.

Tagged with: ,
Posted in Economics

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

“With a Steady Hand”
Welcome to the weblog of Karl-Heinz Thielmann, fund manager, financial analyst, economist and dedicated long-term investor.

Enter your email here to follow "With a Steady Hand".

%d bloggers like this: