Young Economics.

Evolutionary Economics

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I’m confused. Over the last little while we have had some truly scary commentary. We’ve heard about how dire the current recession is via the IMF (link). How world trade has fallen off a cliff (link). How Britain couldn’t unload its recent debt offering (link) . And lots on how bad the Geithner plan is to reform the US banking system. (1) (2) (3).  What’s confusing me are the signs of life starting to show in the economy. Markets have roared in March (link). Consumer spending is improving (link). And housing starts show signs of a bottom (link).

From my point of view, there appears to be a disconnect between what the experts are reporting and hypothesizing (ala the doom and gloom above) and how the regular Joe is actually reacting in the marketplace. Granted, those at the top will come out chucking terms like ‘Bear Rally’ to explain what we’re seeing. They claim it’s all happened before in the past, and our data continues to point us down. But I wonder how relevant the empirics can actually be.

At this point, I imagine Patrick is sitting slack-jawed and stunned, wondering why he agreed to write a blog with me. He loves data. And rightly he should. Economists distinguish themselves from other social scientists by interpreting history methodologically. We cast our eyes over past figures, crunch a few numbers and present sound conclusions from logical study. It’s great. Power over the data has given us power over the economic laws and principles past generations have followed. But here is where the problem lies.

In an earlier post, I briefly sketched the conclusions Rogoff and Reinhart came to in a paper detailing an empiric study into past major financial crises (link). To sum it up, they produced observations about how long recessions typically last, and classified our current situation as quite early in its lifecycle vs. historical precedents. But aren’t there problems with comparing today with yesterday? For instance:

  • Today, we are expansively networked, with current news, results and reports travelling globally within seconds.
  • The crisis is taking place in the US, the world’s economic hub. Every new event has direct implications for every economy, investor and labourer.
  • The US dollar serves as the world’s choice currency reserve, making every monetary decision crucial to central banks everywhere.

To me, these points imply that every statistic an economist could collect today will be much more sensitive to the underlying atmosphere than in the past. The cliff-diving we’ve seen in the data seems to support this hypothesis. But couldn’t this also mean that the bottom could come much faster than before? That recovery could take hold at a faster pace? Unfortunately, we just won’t know until it happens. It would be wonderful to try and quantify the effect of the internet revolution on markets and relationships. To see how defeating the Y2K demon, and fully embracing an open and connected world has changed how people react and relate to things. But we just can’t do it. If you try and build any scientific, economic conclusion from looking at 5 years of data, you are setting yourself up for failure. There’s just no way to make inferences about what’s going since each year is prone to random disturbances.

In my opinion, this is where modern economics fails. The history of the field has placed so much value and weight on method and logic that to step outside the framework would threaten any expert’s status. Imagine the administration is accepting applications to hire a new chief-of-staff economist to solve the crisis. On one, the applicant writes “it appears that x may be occurring, and thus I propose…”, while another contains “the situation is similar to the past, where y was proven to have occurred so I propose…” Today, the second would be seen as the more able economist, and hired to combat the problem.

Of course, to hire the first has its problems. Anyone can formalize an opinion about what’s happening right now, but only a few have conducted rigorous study in the application of economic law. What’s needed is a compromise between the two approaches. This is not so different from the Lucas critique, which criticized using past data realized under older policies to evaluate regime shifts. Here, I am criticizing the reliance on empirically proven economic relationships to hypothesize the current state of affairs. We live in an evolving system which operates under constantly changing rules, norms and beliefs. Shouldn’t we then rely on economists and experts who look at the world from an evolutionary perspective other than an empirically driven one?

Going forward, I believe economists should study history not in hopes of finding any definite laws or outcomes, but looking for signs of trends and change. They can then use their understanding to formalize logical guesses about where we are today that won’t need a structured model to validate the conclusion. In doing, we would be accepting that nothing is the same as before, and nothing will be the same as now. We would be accepting that economics is not a science of law, but a science of evolution.

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Written by jk

March 27, 2009 at 10:00 am

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