Economics IS a science, BUT...

In the Financial Times today (free registration is required but worthwhile) there is a provocative column by Gideon Rachman arguing that economics is a "pseudo-science" and that historians ought to get more of a hearing. There is also a more valuable discussion in an embedded video between Rachman and Martin Wolf (who makes a lot of eminently sensible points and clearly wins the "debate" in my view).

OK, so what are the criteria we should look at to see if economics is a science? Rachman uses a clever trick and pulls a quote from a winner of the Nobel prize for economics, Joe Stiglitz, who wrote that science was "defined by its ability to forecast the future." Actually, he didn't define science that way; he said "If a science..." is defined that way then economics is in trouble because it didn't forecast the crisis. Rachman seizes on the forecasting definition. But it doesn't take long to realize that many sciences do not forecast the future at least not in the sense of accurately predicting exactly when and where certain things will happen. Astronomers can't stake their claim to forecasting the future since the astronomical future won 't be known until long after they are all dead. And biologists don't predict future evolution of most species. And climate scientists didn't predict global warming fifty years ago. And meteorologists didn't predict Hurricane Katrina in advance of its formation. Earthquake scientists can't tell me the day when Vancouver will be hit by the "big one."

I don't think anyone can seriously argue that forecasting the future is the rule for membership in the science club. Rather it's something about being able to systematically understand the mechanisms at work in the field of study. With that understanding you may get predictive ability or you may not depending on the complexity of the system and how well evolved the science has become. Economics is a science since it consists of a set of mechanisms that help us understand the economy. But the subject matter is highly complex, and it keeps on changing. A crisis is a particular combination of effects that causes the current situation to fall apart. It involves individual agents and their interactions in ways that are hard enough to model and close to impossible to predict.

Two more points.

First, even when astronomers predicted the sun revolved around the earth, they were still doing science. Just not doing it very well. Partly because of limited knowledge--it was a young science. Partly becuase the science was infected by religion. That's my worry about economics. It's a science where certain types of secular "religion" have taken hold. We have to shake of this religion to make progress.

Second, in contrast to the humble vision of historians espoused by Rachman, we know from the case of Niall Ferguson that they are not content to say: "Actually, chaps, it was a bit more complicated than that." Instead look at what Ferguson says in another column in the FT: "there invariably came a point when money creation by the central bank triggered an upsurge in inflationary expectations." That sure sounds a lot like someone who has looked at history and elucidated a general law that holds in all situations. Or how about this one: "American stimulus can end up benefiting Chinese exporters; and at a time when there is much under-utilised capacity, so that deflation is a bigger threat than inflation." Ferguson is doing economics in this sentence; he's just not doing it very well. There is no way to see Ferguson as following what Rachman approvingly deems the true function of the historian: "to concentrate on the particular and the specific and to puncture the pretensions of social scientists, with their constant and futile effort to derive general, predictive laws from the study of the past." We can't get by without economics as a science. We have to have some analytical framework that holds across particular instances in history or we would have no basis to formulate policy. We have to do it better. Theories need to be confronted with historical evidence. But we need to do the maths too.

Churchill's 4 Greatest Hits

1. On May 13th, 1940, Churchill gave his first speech as prime minister. He had been appointed only 3 days earlier on May 10th, the day Hitler launched a quadruple invasion of France, Belgium, Holland, and Luxembourg.

I have nothing to offer but blood, toil, tears, and sweat. We have before us an ordeal of the most grievous kind.
We have before us many, many long months of struggle and of suffering.
You ask, what is our policy? I will say it is to wage war by sea, land, and air, with all our might and with all the strength that God can give us, to wage war against a monstrous tyranny never surpassed in the dark and lamentable catalogue of human crime. That is our policy.
You ask, what is our aim? I can answer in one word:
Victory.
Victory at all costs—Victory in spite of all terror—victory, however long and hard the road may be, for without victory there is no survival.

2. On June 4th after the completion of the evacuation from Dunkirk, Churchill again addressed the House of Commons. Although the formal surrender of France did not occur until June 22nd, everyone must have seen it coming. The foremost question in English minds was whether an invasion of Britain would soon follow.

We shall not flag or fail. We shall go on to the end. We shall fight on the seas and oceans, we shall fight with growing confidence and growing strength in the air, we shall defend our Island, whatever the cost may be, we shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills; we shall never surrender.

3. On June 18th "in order to counter panic over the coming news of the French armistice" (Roberts, 2009, p. 85) Churchill spoke again:

Let us therefore brace ourselves to our duties and so bear ourselves that, if the British Empire and its Commonwealth last for a thousand years, men will still say, "This was their finest hour."

4. The Battle of Britain that followed the invasion of France (beginning July 10th, 1940) reached its "zenith" according to Andrew Roberts' Storm of War on September 15 which is "today celebrated as Battle of Britain day." A full month before (August 15th) Churchill, referring to British fighter pilots, gave a line that I will always think of with great affection.

Never in the field of human conflict was so much owed by so many to so few.

And that appears to be the last of the wartime speeches that gave us the immortal lines that I knew as rock lyrics ("finest hour" in the "Finest Worksong" by REM, "never surrender" in a Corey Hart song!) before I even knew their true author and the context in which he spoke them.

I believe we owe an enormous debt to Churchill for those words. They make me proud of our history and of our language. They also may have tipped the balance and kept Britain in the war when there were many who might have made "terms" with Hitler leading to occupation and a Vichy-like state instead of what Roberts refers to as "Last Hope Island." It would be almost 5 years after those speeches before the Nazis were defeated. But it was that summer of 1940 when mere words never mattered more.

Charlatan!

My two least favourite "public intellectuals" are Niall Ferguson and Nassim Taleb. I've posted several times in response to things that Ferguson has written. After an listening to an excruciating interview with Taleb on the otherwise wonderful Planet Money podcast, I wanted to post a grand critique of Taleb to try to debunk the idea that hes' some kind of "deep thinker." Since nobody cares and I actually have real work I ought to be doing, I was very pleased to find this blog post which nails Taleb quite effectively.

Taleb is merely setting himself up as some sort of heretical alpha monkey of the quants for stating the obvious, the misleading, and occasionally the gratuitously wrong-headed and untrue.

I have no idea what an "alpha monkey of the quants" might mean, though I do like the sound of it. But if you listen to the Planet Money interview, you will see what Locklin (the blogger) means in the rest of the sentence.

Locklin also quotes Taleb as saying " Our research shows that economic papers that rely on mathematics are not scientifically valid." This might be obvious, if "rely on mathematics" means excluding any form of evidence. For example: Edward Wilson defines science as the "systematic enterprise of gathering knowledge about the world and organizing and condensing that knowledge into testable laws and theories." So math without reference to knowledge of the world is not science. It's math. But if "rely on" means to use as a necessary part, then this quote falls into the category of "gratuitously wrong-headed and untrue." Locklin has a great response:

I agree that many economics papers are silly. Since economic papers often involve math, his reasoning seems to be something along the lines of “we must do away with mathematics and instead base economic policy on chicken entrails and pixie dust.”

The Parallel Universe Machine

If you're not sure what you think of the $800 bn Obama stimulus, then this is the podcast for you to listen to. Two caveats. First, there may not be anyone who is not sure what they think. Among the people paying attention, I get the impression that everyone is pretty much 100% sure it was a big waste or money or the only thing that kept us from entering another great depression. Second, the podcast is far from conclusive. But at least you get a sense of why we should feel unsure.

The key idea is that as scientists we would like to use the stimulus as an experiment to see if Keynes was right. But quickly we realize that it's a crummy experiment because there's no control group. We need a parallel universe in which everything else was the same but the stimulus was not enacted. But the commentators point out that economists have "parallel universe machines." We use estimated models to conduct counterfactuals. If the model is right, we can say what the parallel universe would look like. According to Mark Zandy, unemployment would be 11.5% instead of 9.5%.

The Planet Money reporters rightly point out we should be skeptical about these models. But they don't get the reason right. They seem to think it's because the world keeps changing so the laws don't stay fixed long enough to figure them out. I don't accept that premise. Rather,the basic problem is that the estimates in the model were created by regressions that lacked a parallel universe. So they use observed time-series and cross-section variation instead. In some cases--my own work, for example ;-) --we can get estimates we trust this way. But for economic stimulus, the problems of holding all else equal in other periods or other places just seem insuperable. Not wanting to end on a pessimistic note, I actually got something really helpful from this podcast: a new metaphor for what I do at work. I'm a builder and operator of parallel universe machines!

Why so slow to recover?

The US economy doesn't look very good these days. What happened to the recovery that seemed to be moving at a pretty good clip last spring? Here are four theories I've been hearing.

1. It's the Greeks. According to this idea, Greece's sovereign debt problems are creating uncertainty and fear. I'm skeptical. In the past far more important economies have had just as big problems without a notable drag on the US economy (Mexico in 94' , Brazil and Russia in 99', most of Asia in '97). So how did we shrug those disasters off but not this one?
2. It's the debt. This is the idea favoured by fiscal conservatives. The idea is that the US government has spent beyond its means and everyone now recognizes that a day of reckoning approacheth. Thus we save now so we can afford to pay our taxes down the road. Yeah, maybe.
3. End of stimulus. The government boosted demand but now that the stimulus is drawing to a close; we would need the private sector to replace falling government demand with rising consumption and investment. But they're not in the mood. Why not? See 1,2, or 4.
4. Deleveraging sucks. Debt was high relative to asset values and asset values were inflated. So debt was really, really high relative to fundamentals. Now that debt has to come down and there's no easy or fast way to do it. This is the theory that makes the most sense to me. It is complementary with theory #3.

Planet Money and the Big Short

My July endorsements are both economics/crisis related. Thanks to a tip from Andy Bernard, I started listening to Planet Money, a podcast from NPR. I download it from iTunes. The reporters are excellent. It manages to be very entertaining while not sacrificing substance. I learn something from almost every episode. In the episode I'm listening to now, they track down homes in Sarasota, FL that were part of a "toxic asset" they bought during the crisis. Three of nine houses they found were investment homes. Another was a second home. I'd been expecting it to be poor, unsophisticated people who had lost their jobs and hadn't been able to make interest payments when their low "teaser" rates expired. I'm sure those victims are part of the larger story but it's interesting to hear about the other side.

I've also been listening to an audiobook of The Big Short by Michael Lewis. The characters are fascinating and you learn a lot too. Though I have to admit that synthetic collateralized debt obligations still confuse me despite Lewis' lucid explanations.

The wisdom of Esther Duflo

I just got around to reading the Ian Parker profile of Esther Duflo in the May 17, 2010 New Yorker. It's worth reading for anyone interested in development policy (which should be most people, I hope). But I found it particularly interesting because of the issues it raises for my profession. What are the central questions that economists are tasked with answering? And how should we answer them?

Here are a couple passages with Duflo quotes that I liked.

Duflo had long wanted to use experimental methods to put microfinance to the test. As she saw it, there was little beyond anecdote to support claims that the technique had a special power to combat poverty, gender inequality, and ill health. This is not to say that Duflo was committed to debunking. "One of my great assets of being in this business, or maybe I've developed it over time, is I don't have many opinions to start with," she told me. "I have one opinion--one should evaluate things--which is strongly held. I'm never unhappy with the results. I haven't yet seen a result a didn't like."

I like this attitude a lot but I often feel the opposite. There's no such thing as a likable result. Our referees at journals tell us "There is nothing surprising in this paper. Your results are obvious." Or they tell us "I don't believe your results at all. They are all spurious." It would seem that Duflo has a talent for designing questions where the results will be plausible and surprising, if only in the sense that no one knew what to expect.

There is an interesting debate over whether economists need to understand the mechanisms at work or whether it is enough simply to find out whether various "treatments" actually work. I think we were probably too much on the mechanism side. We had our theory telling us what to expect via mechanisms such as supply, demand, equilibrium, expected utility maximization, etc. And then as long as we had a supportive anecdote, or a strong introspective intuition, or maybe some observational data consistent with the mechanism we became overly confident that we really understood how the world worked enough to prescribe policies.

"It can't only be the data," Duflo said, showing a rare willingness to generalize. "Even to understand what data means, and what data I need, I need to form an intuition about things. and that process is as ad hoc and impressionistic as anybody's."

It can't only be the data, but there must be data. "There is a lot of noise in the world," Duflo said. "And there is a lot of idiosyncrasy. But there are also regularities and phenomena. And what the data is going to be able to do--if there's enough of it--is uncover, in the mess and the noise of the world, some lines of music that actually have harmony. It's there, somewhere."

That's a gorgeous expression of an inspiring thought. But don't worry I'm not going to abandon my office and take to the field, running randomized experiments. I am very glad economics has made room for and even celebrates (Clark medal) this sort of work. But I have been brought up to believe that the data is given and it is our job to find the data,, assemble it, clean it, massage it, scrutinize it, and finally interpret it (via econometrics). Nothing in my education, experience or natural aptitudes has prepared me to go out and create the data.

This Month's Endorsements

Mostly getting old is just a long (or not-so-long) bumpy road downwards. But on thing I like about getting old is my increased enjoyment of finding really good things. I feel like I have the experience to make a sound judgment of quality. So here goes a new monthly feature of my blog.

• Far From the Madding Crowd, Oxford pub on Friar's Entry, very near Borders, quite close to the central bus station. Everchanging but always excellent beer selection. Good prices (2.5 for a pint of the daily special). Well-lit. Free wireless. Quiet enough for work or conversation. Welcoming. My favourite pub in the world!
• India Pale Ales: Jaipur from Thornbridge, Mahseer from Green Jack, and Carronade from TRYST.
• The Partridge, great French food in Wallingford. The best restaurant food I've had in England. Please, please go there. It needs more support!
• Outnumbered. Funny. Painful. Painfully funny. My favourite comedy since Thirty Rock.
• New College, Oxford. Medieval walls just do it for me.
• Bath, my favourite English city, in Somerset, my favourite county.
• The Cotswold Way, especially Wotton-under-edge and Painswick.
• Robert Schumann
• Music at St Peters, Wallingford
• Nicola Benedetti, Scottish violinist

World Cup Country Rankings and Betting Odds

The ranking information:

1. FIFA ranking
2. ELO ranking
3. UBS predictions, model based on past cup performances, home advantage, and the ELO rating (which is based on recent game outcomes taking into account strength of the opposition)

The betting odds:

1. World Cup Betting Directory
2. William Hill
3. Sportsbook

Sign of the Times

According to a study done for the British Beer and Pub Association, 39 pubs close each week in the UK. More specifically, there were 1566 closures between June and December 2009. The good news is there are 52,000 total pubs and there were 553 pubs that opened. I personally suffered from the phenomena of pub closures on the third and fifth days of my walk along the Cotswold Way. On Day 3 (Painswick to Dursley) we arrived in Ryeford, expecting refreshment at a pub indicated on our map. As you can see in the picture on the left we arrived too late. The Ryeford Arms was boarded up. We asked a man walking through the parking lot where we could find a pub nearby. We suggested King's Stanley (which was on the way, more or less) but he said their pub had closed too. Responding to our disappointment, he put it simply as, "Sign of the times." Fortunately he told us about a pub at 3/4 miles in the wrong direction (The Woolpack in Stonehouse) that was indeed open and making good lunches. Two days later we came up the pub shown in the picture on the right just north of the town of Cold Ashton. This pub may not close I suppose if a new publican is found but I think the To-Let sign is indeed an accurate reflection of the difficult economics of pubs in England today.

So what is the problem? I suppose one simple thing is that drinking is down. Since more people have cars, they are less obliged to frequent the local pub. Land values are up, making the opportunity costs of pubs rise. One thing that would seem to go against the land story is the highest rates of pub closure (-3% per week according to the study!) are in the regions called Tyne Tees and Granada (northern England) which are probably not the areas of high housing price increases. In Central and Southern England entry is higher relative to exit (but still net exit).

Secret of Human Success? Trade

At some point after millions of years of indulging in reciprocal back-scratching of gradually increasing intensity, one species, and one alone, stumbled upon an entirely different trick. Adam gave Oz an object in exchange for a different object...The extraordinary promise of this event was that Adam potentially now had access to objects he did not know how to make or find; and so did Oz.

The claim that Ridley makes in a new book reviewed here, is that Neanderthals had comparable brains to Homo Sapiens but evidence suggests they relied on local resources whereas some 80,000 year old seashells have been found far from the nearest coast, which anthropologists infer to have been used in barter.

I like this because it shines the spotlight on my academic specialty: international trade. But now that I think on it, I'm no longer sure humans were the first species to trade one item for another. There was a BBC article a year ago about male chimps trading meat for sex!

Parasitism of the -isms

Empires bought stability at the price of creating a parasitic court; monotheistic religions bought social cohesion at the expense of a parasitic priestly class; nationalism bought power at the expense of a parasitic military; socialism bought equality at the price of a parasitic bureaucracy; capitalism bought efficiency at the price of parasitic financiers.

quoted in John Tierney's NYT review of Matt Ridley's new book, the Rational Optimist. I like this way of thinking. It helps to explain why society has not ever discovered a perfect social organization. Inherent in each approach is a tendency that undermines its performance in the long run. I would add that pro-labour policies also run the risk of parasitism by militant or obstructionist unions.

Where can we go?

A lot of Republicans today have argued that this health-care bill smacks of European socialism, or a European “nanny-state” government.

Representative Jeff Fortenberry, Republican of Nebraska, discloses that a little boy the other day asked him, “if the government gets so bad, which country should we move to?”

Umm yes, Johnny, where can we find another highly developed country which declines to provide health insurance to over ten percent of the citizens?

Oh wait...THERE AREN'T ANY!

Ok, but there must be lots of miserable citizens of "nanny states" like France. Can't we bring them over to America to testify to the horrors of life under French medical care? Errrr, no. Because the French like their system.

Ferguson's pseudo-science of Empires

My good friend from Arpoador, who knows how to push my buttons, sent me a link to this recent LA Times article by Niall Ferguson (who i have railed about in a past post). Like many social scientists before him (including Paul Krugman), he has become seduced by the science of complex systems, with their self-organized criticality, tipping points, phase transitions, etc. I find this stuff really cool too. But how much does it really help understand social science (either explaining past social events or predicting future ones)?

The sudden collapse of the Soviet Union does look like the kind event described in the complexity models. But i don't think we can overlook the personal role of Gorbachev who could have elected to resist the breakdown but opted to facilitate it.

Now think back to the Great Depression, another collapse, it would seem, of a complex system.
But Hoover and the Federal Reserve didn't resist either, they took actions that probably accelerated the collapse.

Now think of the most recent crisis: Paulson, Bernanke, Geithner, Summers, and Obama all resisted the collapse--pushing back with aggressive monetary and fiscal policy--and succeeded in preventing another great depression. Billions of people whose livelihoods were saved should breath a sigh of relief that Bernanke et al didn't consult with Ferguson, who apparently thinks easy money and stimulus will cause America's collapse, whereas the near obvious truth is that they prevented it.

Last point: in the traditional use of the word, Empires need colonies or at least a large swath of conquered territory. What is America's empire? Puerto Rico, Guam? He can't be referring to a couple small islands. Ferguson must be talking about Afghanistan and Iraq but these are not America's colonies; they are policing actions. US losses in Afghanistan are very sad, as are the associated civilian deaths but the numbers are very small relative to past conflicts that ended empires. And recently the US and Afghan army took over the Taliban's last city in Afghanistan (Marja). So how do we see echoes of the past (Soviets, English, and Greek disasters in the region) in the Afghanistan of 2010?

Ok, really last point. The suspicion that he's become a total charlatan hardens further when he starts quoting that other great charlatan about "fat tails" and "black swans".

The Lantau Grind

Today's hike reminded me of the Grouse Grind in Vancouver. The ascent from the bus-stop Pak Kung Au is pretty much all stairs and no switchbacks so I found myself pausing frequently to catch my breath. Well the Serious Hiker's Guide to HK gives it 3 boots and that is not because of length (about 2 hours from Pak Kung Au to Ngong Ping).

The bummer for us was that from the very beginning we were stuck in a cloud from which we did not emerge until we descended to Ngong Ping (where there is monastery, giant Buddha, and a good vegetarian restaurant). We got nicer views (of the airport, water and apartment estates) on the descent to Tung Chung. One interesting thing about our route was the variety of public transit: tram to Central, Ferry from Central to Mui Wo on Lantau Island, bus to Pak Kung Au, and MTR back to Wan Chai from Tung Chung. Special note: Starz Wine Bar offers pints of San Miguel (Philippine lager) for 38 HKD (about 5 USD) just outside the Tung Chung station.

Recommended hike. I will have to do it again on a sunny day!

Krugman on insurance

Krugman answered questions recently for the New Yorker. Some of the answers were so well put.

example 1:

QUESTION FROM ERIK DONNELLA: Why should (or shouldn’t) health insurance be for profit?

PAUL KRUGMAN: I think at a fundamental level the point is that what we want is broad coverage—it’s a widely shared social goal—but that’s not what private insurers are trying to achieve; from their point of view profits are maximized by not covering those who need it most. Long ago we made the decision that seniors should have guaranteed coverage via Medicare; there’s no real reason to apply different logic to those under 65.

After reading this, I was all "right on!" "how could anyone not agree with this logic?" But then I saw the flaw...If private insurance is that bad, why do we use it for our homes, possessions, our trips, dental, rental cars...

I guess my answer is that I don't. The only insurance I buy is what is mandated by law.

Example 2:

QUESTION FROM NATE: .... how am I to make sense of the constant alarm about USA’s credit rating being raised in the news?

PAUL KRUGMAN: ...for now I would disregard the deficit hawks...

...I’m especially baffled by the idea of taking insurance against a U.S. default. If America defaults, we’re talking about a chaotic world—Mad Max, more or less—in which case, who imagines that insurance claims will be honored?

the best deal ever!

Friday we ate lunch at Akavit,

a restaurant on the hillside above the road between Patong beach and Tri Trang beach.

I think it's called Akavit but the two cocktail glasses after the "k" might represent a letter.

although the sign advertises "Swedish chefs," it seems the Swede is the owner and he's in Sweden. Our chef/waiter/manager was Thai and a super nice guy.

We ordered Paeneng curry (chicken), Pad Thai (shrimp), morning glory (veg), and steamed rice. To quench our thirsts we shared 3 Singha beers. Total bill: 360 baht or $11.

And did i mention the sea view?


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A good theory

I'm reading Richard Dawkins' The Greatest Show on Earth. It's really good--the evidence of evolution that he provides is fascinating and compelling. On page 149 Dawkins writes

a good theory , a scientific theory,is one that is vulnerable to disproof, yet is not disproved.

He gives the example of Haldane's response to the question of what evidence disprove the theory of evolution: "Fossil rabbits in the Precambrian." But I think Dawkins is not quite right. Suppose fossil rabbits did show up and were reliably dated far before the first mammals? Would we stop believing in evolution? I don't think so. We (well, the main problem would be for biologists but all believers in evolution would have to be pretty disturbed) would have a huge problem. But as someone named Dobzhansky once wrote, "Nothing in biology makes sense except in the light of evolution." Fossil rabbits in the Precambrian wouldn't make us abandon the of evolution because we need the theory to account for so many things that we observe. And there's no plausible alternative. So in light of this, I propose a new definition:

A good scientific theory is the most internally consistent and evidence-based framework for making sense of the complex phenomena we observe in the world.

Movie update

I watched the Hurt Locker. I had to watch it in two installments because it is so intense. It MUST be the best movie of 2009. That's not based on an extensive viewing of 2009 movies. It's based on my larger sample of movies over the last 30 years. The Hurt Locker is so good that the only way there could be a better movie in 2009 is if it were an off-the-charts year!

I also saw Funny People on the plane. Definitely worth seeing on a plane.

Now I really want to see Inglorious Basterds.