Economics Again

The Noble Prize in Economics, it is not really a real Noble Prize but let's not split hairs, went to two opposing schools of thought. One of those schools went about telling everyone they could why they were right and the other fellow was wrong. Today's NY Times presents one of the arguments.

The author, one of the "Winners" states:

Actually, I do not completely oppose the efficient-markets theory. I have been calling it a half-truth. If the theory said nothing more than that it is unlikely that the average amateur investor can get rich quickly by trading in the markets based on publicly available information, the theory would be spot on. I personally believe this, and in my own investing I have avoided trading too much, and have a high level of skepticism about investing tips. 

But the theory is commonly thought, at least by enthusiasts, to imply much more. Notably, it has been argued that regular movements in the markets reflect a wisdom that transcends the best understanding of even the top professionals, and that it is hopeless for an ordinary mortal, even with a lifetime of work and preparation, to question pricing. Market prices are esteemed as if they were oracles. 

This view grew to dominate much professional thinking in economics, and its implications are dangerous. It is a substantial reason for the economic crisis we have been stuck in for the past five years, for it led authorities in the United States and elsewhere to be complacent about asset mispricing, about growing leverage in financial markets and about the instability of the global system. In fact, markets are not perfect, and really need regulation, much more than Professor Fama’s theories would allow. 

 Point well taken, indeed there is all too often insider information, timing variances and technological leverage, and finally cost leverage. High speed trading is a way to beat the market, a way that actually drives values of equities, not just responds to them. The price may reflect many things, the last trade, the latest financial release, the health of the president. It may reflect the past, present and future. Furthermore it may reflect guesses and hopes. 

I wrote a piece on the Rowe Conjecture a few years ago. This was a conjecture by Nick Rowe where he speculated the idea that perhaps the real world oscillates between reality and assumption. Rowe is one of the more realistic of economists, often rationally questioning assumptions and not just pontificating on high. Rowe often brings a sense of the common to economics.

Now to refresh on the Rowe Conjecture. We can assume that the EFH, efficient market hypothesis, actually is in play or not, and likewise we can oscillate between what people think, that it works or not. The result as I demonstrated using a simple analysis is an oscillating market of highs and lows all do to what people think and what reality is doing. This is kind of balancing the views of the two contestants in the economics war of words, which seems to be just one sided now.

But last week the Times had a piece by some Harvard economist alleging that fundamentally Economics was a science. The author states:

It is true that the answers to many “big picture” macroeconomic questions — like the causes of recessions or the determinants of growth — remain elusive. But in this respect, the challenges faced by economists are no different from those encountered in medicine and public health. Health researchers have worked for more than a century to understand the “big picture” questions of how diet and lifestyle affect health and aging, yet they still do not have a full scientific understanding of these connections. Some studies tell us to consume more coffee, wine and chocolate; others recommend the opposite. But few people would argue that medicine should not be approached as a science or that doctors should not make decisions based on the best available evidence. 

As is the case with epidemiologists, the fundamental challenge faced by economists — and a root cause of many disagreements in the field — is our limited ability to run experiments. If we could randomize policy decisions and then observe what happens to the economy and people’s lives, we would be able to get a precise understanding of how the economy works and how to improve policy. But the practical and ethical costs of such experiments preclude this sort of approach. (Surely we don’t want to create more financial crises just to understand how they work.) 

Yes, go pick on medicine. They are just a bunch of "witch doctors".  Or as the author appears to argue they are just like economics. Not really.

Consider Biology; in the first half of the 20th century it was slowly moving from a study of classifying "stuff". After all Jim Watson was originally an ornithologist, a studier of birds. But in the early 1950s Biology went from something akin to economics, a collector of data, and a proposer of relationships, to a real science. DNA made that possible. Now regarding science we have the ability to predict and then test our predictions. We now know that BRAF V600 is a gene which enables melanoma to aggressively metastasize. We know where it is in the internal pathway of the cell and we can, understanding the structure of the gene, deliver a therapeutic to block it and stop the growth. We also know that MEK can then become aberrant and we have a way to block it. We have a road map, we can make predictions, we can design a therapeutic, and it works, every time. Can any economist say that? No way. So the author of the above piece, Harvard not withstanding, has somehow missed what has happened to medicine. It is now truly a science.

Economics is where plant classification was in the 19th century, at best. One collects data, looks at relationships, and perhaps fins a new species. One cannot not predict what will happen. Medicine can, everything that is a science can. The introduction of imatinib for CML, a kinase inhibitor, was the first break out point for medicine in such a new world. There is no such example for macroeconomists. 

Consider one of the final statements:

Using a data set with anonymous records on 2.5 million students, we found that high-quality teachers significantly improved their students’ performance on standardized tests and, more important, increased their earnings and college attendance rates, and reduced their risk of teenage pregnancy. These findings — which have since been replicated in other school districts — provide policy makers with guidance on how to measure and improve teacher quality. 

 In my opinion this is an ad hoc propiter hoc argument. Bad teachers are just that, bad. I had a few, so what does one do, find a way to work around them. No, not every student can do that, but it does challenge the good students to actually get better.

Overall, economics is at best two things; (i) the collection of data and its analysis, and, (ii) the proposal of political views oftentimes using ersatz mathematics. Mathematics for building a bridge is good mathematics. Mathematics for proposing a social policy is "shingling the roof in the fog".