Tag Archives: economics

Does economics need *more* physics envy?

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It’s often said by critics of economics that the problem is economists have physics envy: they want to describe the economy using models that are over-complicated in the mathematics, mimicking classical physics, and under-sophisticated in its understanding of how humans actually make choices. But in [amazon_link id=”1408827379″ target=”_blank” ]Forecast: What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics[/amazon_link] by Mark Buchanan argues that economists haven’t been paying enough attention to physical.

[amazon_image id=”1408827379″ link=”true” target=”_blank” size=”medium” ]Forecast: What Physics, Meteorology, and the Natural Sciences Can Teach Us About Economics[/amazon_image]

He makes the argument in the context of financial economics and its discrediting by the financial crisis. I find it a wholly persuasive thesis. Rational choice theorising just cannot account for the data on financial markets – the numerous self-reinforcing large price movements without specific causes, the long persistence in the absolute size of price movements, the fractal character of the movements on annual, monthly, daily, hourly, nano-secondly timescales. However, models from statistical physics can do so. The empirics of financial markets are similar to those of earthquakes, for example, well described by power laws. Economists should be using these tools as their starting point for theorising rather than starting with theories that fit the data about as well as Cinderella’s glass slipper fits the feet of the Ugly Sisters. It astonishes me that so many economists are so resistant to believing the evidence of the data – as I wrote describing here last autumn’s ESRC symposium on macroeconomics and the reception physicist J.P.Bouchaud got from some of the other participants.

Forecast is a useful and very accessible guide to the physics models, although this is not untrodden territory in pop science. For example, Philip Ball’s [amazon_link id=”0099457865″ target=”_blank” ]Critical Mass[/amazon_link] covers it too. There were a few points when I felt it over-claimed. For example, Mr Buchanan compares events in California’s electricity market in summer 2000 to the financial market events of 1998 or 2008, when it turned out later that Enron traders were manipulating the market. From this he concludes: “Blind faith in the benefits of privatization has had negative social consequences, including the deterioration of overall social trust, the dissolution of traditional non-market relations based on social norms and the replacement of cultural incentives to ‘do a good job’ with purely monetary incentives.” This is a perfectly valid line of argument, made by many other people – [amazon_link id=”0374533652″ target=”_blank” ]Michael Sandel[/amazon_link] most prominently of late – but it is a different argument entirely from the rest of the book, and I think isn’t supported here. There are one or two other points where the book canters through a separate area – such as behavioural economics and fast versus slow thinking – interesting but not related to the main argument.

For the main point here is about the prevalence of disequilibrium in economies, and the consequent inappropriateness of equilibrium as the starting point for economic modelling; the inadequacy of comparative statics in a dynamic world; and the role of social influence in markets. There is a very interesting section on the way the ‘wisdom of crowds’ is valid for independent decisions but destroyed when people know what others think, when it is replaced by the ‘unwarranted confidence of crowds’.

The most intriguing point the book raised for me concerned the predictability of financial market prices. Markets seem to have two phases of behaviour, like water versus ice, and the transition from one to the other is particularly interesting. “When the number of participants is smaller than a certain threshold… the market always has some predictability in its movements,” Buchanan writes of some experimental research (by Yi-Cheng Zhang and Damian Challet, written up in the book [amazon_link id=”0198566409″ target=”_blank” ]Minority Games: Interacting Agents In Financial Systems[/amazon_link]). Beyond a threshold number of people, the predictability vanishes. The number is related to the amount of history participants take into account in their expectations of the future – beyond that “the space of strategies becomes effectively covered or crowded.” There will be somebody in the market who will pounce on any predictable pattern to arbitrage it, and any predictability vanishes.

Economists who have already read about complexity economics – say in Paul Ormerod’s [amazon_link id=”0571279201″ target=”_blank” ]Positive Linking[/amazon_link] or his older [amazon_link id=”0465053564″ target=”_blank” ]Butterfly Economics[/amazon_link], or Alan Kirman’s [amazon_link id=”0415594243″ target=”_blank” ]Complex Economics[/amazon_link] or Benoit Mandelbrot’s [amazon_link id=”1846682622″ target=”_blank” ]The Misbehaviour of Markets[/amazon_link] – will find much of the material in Forecast familiar. But even they will find some new insights. Economists who haven’t paid much attention to these areas should read this book and apply some of our profession’s (supposed) newly-found humility to its argument. And this is a very accessible book for non-economists (and indeed for non-physicists), who will find it interesting and wonder why on earth some economists resist learning across the disciplinary boundary.

Shooting star

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I’ve spent a very interesting day talking to economists and others in Oxford today, a holiday as far as I’m concerned after a solid stretch of meetings, and revising the draft of my next book. The sun shone, after a few days so bitterly cold that the chill gets into the gaps between your bones. I spotted – for the first time in all the years I’ve been visiting/living there since my big brother was a student in the late 1960s – this chap:

Pan

On the train to and fro I read a short e-book, [amazon_link id=”B00BBJCUUW” target=”_blank” ]Shooting Star: The Brief and Brilliant Life of Frank Ramsey[/amazon_link] by Karl Sabbagh. It’s an absorbing biography of somebody I knew only because his name is attached to optimal taxation theory. He was evidently an extraordinary characted, who led a colourful life on the edge of the Bloomsbury Group, made profound contributions to mathematics and philosophy as well as, en passant, to economics, and translated Wittgenstein – correcting errors – in his spare time as an undergraduate student. He died at only 26, perhaps due to medical error.

The most telling paragraph describes his first two published papers:

“With ‘Universals’ and ‘The Foundations of Mathematics’, Ramsey had established a pattern of reasonably short, down-to-earth, clearly-written papers which said something fundamentally new. He had written only 16 such papers by the time he died, and each had ideas that were to resonate for the next 80 years.”

Only?!

If you know nothing much about Ramsey either, this book is well worth taking on a train or plane ride.

[amazon_image id=”B00BBJCUUW” link=”true” target=”_blank” size=”medium” ]Shooting Star (Kindle Single)[/amazon_image]

Advice to young economists

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Today I gave a talk to sixth formers at Gosford Hill School, near Oxford: “I never meant to become an economist,” was the title. (This was via the excellent Speakers for Schools initiative set up by Robert Peston.)

It was a riff on my own career history, and what being an economist means, set in the context of some of my family history and the structural changes in the economy between 1935, when my dad started work at 14, and now, as the young people think about their future careers. Here’s my dad in his first job, front row extreme right. He stayed there most of his working life, apart from the army, although after the mill closed in the late 1970s he was lucky enough to find a job as a meter reader.

Joseph Coyle, The Old Ground Mill

The students were extremely polite and asked lots of good questions. One was what I’d recommend them to read to see if they were interested in economics at university. Off the top of my head, I recommended Tim Harford’s [amazon_link id=”0349119856″ target=”_blank” ]The Undercover Economist[/amazon_link] (which turned my eldest boy into an economist) or any of his books, the Keynes- Hayek rap, Thomas Schelling’s [amazon_link id=”0393329461″ target=”_blank” ]Micromotives and Macrobehaviour[/amazon_link], Ha Joon Chang’s [amazon_link id=”0141047976″ target=”_blank” ]23 Things They Don’t Tell You About Capitalism[/amazon_link], and anything by David Smith, like his recent [amazon_link id=”1781250111″ target=”_blank” ]Free Lunch[/amazon_link]. I forgot to mention Ariel Rubinstein’s [amazon_link id=”1906924775″ target=”_blank” ]Economic Fables[/amazon_link]. There are surely lots of other good resources I should have mentioned too – but not [amazon_link id=”0141019018″ target=”_blank” ]Freakonomics[/amazon_link], which I found too gimmicky.

[amazon_image id=”0349119856″ link=”true” target=”_blank” size=”medium” ]The Undercover Economist[/amazon_image]

Educating economists

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How well are universities teaching their economics students? This is the question a number of academic and non-academic economists have been addressing since a conference this time last year held under the auspices of the Government Economic Service and Bank of England. The conference papers were published as [amazon_link id=”1907994041″ target=”_blank” ]What’s The Use of Economics: Teaching the Dismal Science After the Crisis[/amazon_link] – reviewed by Declan Jordan yesterday in the LSE Review of Books.

[amazon_image id=”1907994041″ link=”true” target=”_blank” size=”medium” ]What’s the Use of Economics?: Teaching the Dismal Science After the Crisis[/amazon_image]

The debate continued yesterday at a meeting of several dozen economists held at the Treasury, working towards a statement suggesting some directions for curriculum and teaching reform, although of course it will be for individual university departments to decide whether or not they think change is needed. The statement will be published after a bit of revision and discussion.

At the meeting Wendy Carlin presented an updated model from her [amazon_link id=”0198776225″ target=”_blank” ]macroeconomics text with David Soskice[/amazon_link], integrating a financial sector into the basic three equation model. Their new textbook will be published later this year and will obviously be well worth while. Wendy cited Claudio Borio’s excellent paper on what we’ve learnt about the financial cycle and macroeconomics, thanks to the crisis.

All-powerful economists?

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There are really two separate books rubbing shoulders in [amazon_link id=”0857284592″ target=”_blank” ]Economists and the Powerful: Convenient Theories, Distorted Facts, Ample Rewards[/amazon_link] by Norbert Häring and Niall Douglas.

One of them is a clear and well-made case that modern economics has been in error in ignoring the part played by institutions, politics and power relations in actual economies. It has chapters covering the acquisition and abuse of power by the financial services industry, the distortion of business in the interests of executives rather than customers, employees or shareholders, and the increasing concentration of the US economy through merger waves. Although many or most professional economists who work in business or regulators or consultancy have always been well aware of institutional detail, I think it is fair comment that academic economics overlooked the reality of markets and economies for too long. I’d also add that this has been changing quickly, with the rise over 20 years of institutional economics, behavioural economics etc (see [amazon_link id=”0691143161″ target=”_blank” ]The Soulful Science[/amazon_link]) – but there is further to go.

The second book within this set of covers is more tendentious. It is a history of economic methodology in the first chapter (I must say, I’d have put this at the end if I’d been the author). While the authors land some punches, and make some good points about the way theory shapes reality (see my Tanner Lectures on this question of performativity), they are too conspiracy theorist about it. The original spin-meister Edward Bernays is wheeled out, along with the Inside Job accusations that the financial crisis came about because some economists were paid to write a report by the Icelandic government. Although many economists in universities do paid consulting work – and should certainly declare it when they publish their work – I don’t believe there is signficant distortion of what gets published as there seems to be in the case of pharma companies and medical research. The economists simply have a much wider choice of options, and are not beholden to one set of powerful business interests. There would be something interesting to say, nevertheless, about the narrowing of economic research as published in mainstream journals – I just don’t believe it’s as crudely marxist as suggested here. Similarly, the way economic theory and practice developed from the 1940s to 1980s was certainly bound up with the wider ideological/political climate (like any social science discipline is sure to be), but not in such a purposive way. I think the messy sociological reality of the profession would be far more interesting to understand than the ideological, top-down assertions presented in this book.

Still, it’s an interesting read. The argument that marginalism, the refusal to compare individuals’ utility and rational choice added up to the inevitable demotion of interest in economic institutions is quite interesting. Besides, I’m all in favour of economists continuing to introspect for at least as long as the world economy remains in such a fragile state.

[amazon_image id=”0857284592″ link=”true” target=”_blank” size=”medium” ]Economists and the Powerful: Convenient Theories, Distorted Facts, Ample Rewards (The Anthem Other Canon Series)[/amazon_image]