Economics vs. reality

With thanks to Lars P Syll for this argument about how far we should go to make economic models.  He concludes:

It is better to be vaguely right than precisely wrong

economics_versus_reality-e1431153441673Denicolò and Zanchettin, in an article published by the prestigious Economic Journal, claim to have shown among other things that “stronger patent protection may reduce innovation and growth.” As a…

Source: Economics vs. reality

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What’s the point of economists?

Just had to reference this article from Economia – the magazine for Chartered Accountants.

It starts off by saying that economists only get things right about 4 times out of 10.  If I have read the grade boundaries issued by one of the exam boards correctly that would have been enough to get a grade F at GCSE economics units 11 and 12.  And if we use the lower mark “3 or 4 times” offered later in the article it is barely even enough for a grade G.

It then goes on to say economics is not a black and white science – but then what is?  Even the physics of light has to take account of colour.

The profession is likened to a sports coach who cannot guarantee a win even by putting out the best team possible.  Except that economists do not seem to get the sack for repeated poor performance.

Or economists should be likened to medics who would not be able to predict when you are going to get ill but should be able to advise you how to get better.  Except that economists do not seem to be able to agree on a course of treatment – should we spend our way out of recession or should we cut back on public expenditure to balance the books.  Or should we do a George Osborne and try a bit of both – cut back on public expenditure till it hurts and still borrow more.

And then the article talks about the benefit of hindsight giving us 20/20 vision.  But again I am not sure that it does, as economists don’t seem to be able to agree whether they should have been expected to predict the 2008 financial crisis.

But perhaps I am biased in my thinking that economics is not science if we follow the Oxford dictionaries definition:

The intellectual and practical activity encompassing the systematic study of the structure and behaviour of the physical and natural world through observation and experiment

It is included as a social science:

The scientific study of human society and social relationships

which attempts to use scientific methodology but is severely limited because it is not easy (or even legal) to experiment on human society and relationships – so that it is limited to observation without being able to test any theories about how economics works.

On the consistency of microfounded macromodels

Having trained as a mathematician I can say that mathematics was great fun but for most of the time, simple arithmetic is all that I need as a real world accountant.

Sadly it looks as though economists enjoy their theories so much that they forget that they are supposed to be doing something useful.

LARS P. SYLL

“New Keynesian” macroeconomist Simon Wren-Lewis has a post up on his blog, trying to answer a question posed by Brad DeLong, on why microfounded models dominate modern macro:

Brad DeLong asks why the New Keynesian (NK) model, which was originally put forth as simply a means of demonstrating how sticky prices within an RBC framework could produce Keynesian effects, has managed to become the workhorse of modern macro, despite its many empirical deficiencies …

16527659-Abstract-word-cloud-for-Microfoundations-with-related-tags-and-terms-Stock-PhotoWhy are microfounded models so dominant? From my perspective this is a methodological question, about the relative importance of ‘internal’ (theoretical) versus ‘external’ (empirical) consistency …

I think this has two implications for those who want to question the microfoundations hegemony. The first is that the discussion needs to be about methodology, rather than individual models. Deficiencies with particular microfounded models, like the NK model, are generally well understood, and from a microfoundations point of view…

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A new way of looking at economics?

I have been thinking recently.  It is a difficult and sometimes painful process I would prefer to avoid.

I have been thinking about how we measure economies and whether GDP is helpful or not.  One issue with GDP is that everything is measured in terms of finance and that does not always give reliable results.  For example I know I am well off because my house is warmer than the house I grew up in – because of improvements in insulation and heating, not because I have more finance than my parents.

And then I heard something on the news this morning.  As a result of the Ebola crisis, they (I cannot remember who was talking) think that Sierra Leone’s economy will shrink this year, whereas its GDP had been projected to rise by 11%.

Would 11% growth in GDP have been a real measure of the countries economic strength?  We know from frequent news reports that the country does not haGraph of somethingve anything like the health care that we (in an ailing economy which cannot manage 3% GDP growth) take for granted.

So do we really want to compare GDPs or are there better measures available?  Should we care about these financial measures at all, or would it be better to measure happiness (as they do in Bhutan) or what should we measure.

Perhaps we could look at some social measures – education, employment, quality of housing stock, health care – but these might be difficult to quantify.

But if we are going to look at financial measures, we need to get away from GDP.  Economic analysis says that another way of looking at GDP is that most of it comes from  bank lending and government deficits (government borrowing).  See my previous post Steve Keen visits solvent land (2) for more detail on this.

Some may say that this is fine, but recent experience of debt shows us that some, if not a lot of, debt is an illusion – it cannot be repaid and is therefore of no value.  As a result we have written off debts of countries (under the HIPC initiatives);  we have bailed out banks who lent too much to people who could not pay.  So if neither bank borrowing nor government borrowing are secure, GDP, the main economic measure we use, is overstated.

So let’s look for something which better reflects what is important – and the size of our mortgages – personally or as a country – is not the right place to start.

Steve Keen visits Solvent Land (2)

OK,  I cheated.  I did the easy bit in my post last week.  There is an issue around the ability for governments to run deficits, and this comes in two flavours –

  1. running a deficit to boost an ailing economy (something which is less likely to happen if we make finance simpler by stopping commercial debt) and
  2. running a permanent deficit because it is always good to boost the economy (which is true according to Steve Keen).

I deliberately ducked the much harder questions around what money is and whether we need banks and governments running deficits simply to exist. Continue reading

Link

Diversity not specialisation

Now here’s a thought.  New research suggests that a strong industrial economy does not want to specialise in one thing but have lots of companies that specialise in related complex things.  So, for example,  the F1 industry in the UK should be a good thing for us and not just a “nice to have” add-on to our financial services sector.

Steve Keen’s post even has a pretty diagram to demonstrate the point, although I would like to know what all the green lines mean and why the UK comes so low when it produces so many products.  Look forward to the published research

What are we trying to measure?

There was a lovely article on the news recently which said that the Italians were now including sex and drugs in their GDP figures.  I am afraid the only reference I can find at present is to an article in Bloomberg of 21 May.  But the point seems to be confirmed.  And indeed the UK GDP figures may also need to include whatever we can measure of prostitution and illegal drug sales.

This has made me wonder why this is something we are so keen to measure and get so excited about (when it goes up) or depressed with (when it goes down).  And why do we compare GDP and borrowing so much as a way of seeing if the borrowings are affordable. Continue reading

Debt 101

Aside

I am worried.

One of the blogs I watch is published by Steve Keen and he has recently (at the beginning of the month) published a three blogs looking at whether governments should run surpluses or not.  This was in response to a proposition from the Australian National Commission of Audit that the government should “live within its means.”

His three blogs are:

Should governments run budget surpluses?

Should Governments run Deficits? a Minsky Model?

Should governments run permanent surpluses? (2)

His conclusion (based on some numbers using his modelling software) is that running budget surpluses takes money out of an economy and effectively reduces growth.

On the other hand running a balanced economy (no surplus or deficit) will see public debt reducing.  But running a deficit has higher growth.

So is a deficit economy a good idea?

It matters because if we remove the possibility of debt (commercial lending) from an economy, then it must follow that a government cannot run a deficit – because it cannot borrow.

Or is lower growth a price worth paying for the advantages of taking debt out of the system?

 

Link

Steve Keen responds to a recent blog from Paul Krugman.  He paraphrases Paul Krugman’s post as:

No need for change, boys and girls: main­stream eco­nom­ics has every­thing under con­trol. We missed the cri­sis just because we failed to observe the shenani­gans in the shadow bank­ing sys­tem. Once we realised our obser­va­tional errors, we had all the nec­es­sary tools and knew what to do (oh, and what the rebels said would hap­pen didn’t any­way, so there!). The sta­tus quo is fine: move along folks, noth­ing to see here…

For a more complete look at the arguments (and the full blog from Paul Krugman) go to the full Australian Business Spectator article Why Krugman needs a new school of thought