Thursday, March 9, 2017

Russ Roberts on Economic Humility

Russ Roberts has an excellent essay, What do economists know? on economic humility. (HT Marginal Revolution)
A journalist once asked me how many jobs NAFTA had created or destroyed. I told him I had no reliable idea. ... 
The journalist got annoyed. “You’re a professional economist. You’re ducking my question.” I disgreed. I am answering your question, I told him. You just don’t like the answer. 

A lot of professional economists have a different attitude. They will tell you how many jobs will be lost because of an increase in the minimum wage or that an increase in the minimum wage will create jobs. They will tell you how many jobs have been lost because of increased trade with China and the amount that wages fell for workers with a particular level of education because of that trade. They will tell you that inequality lowers health or that trade with China reduces the marriage rate or encourages suicide among manufacturing workers. They will tell you whether smaller classrooms improve test scores and by how much. And they will tell you things that are much more complex — what caused the financial crisis and why its aftermath led to a lower level of employment and by how much.
And Russ continues, with great clarity, to explain just how uncertain all those estimates are.

So what do economists know? As Russ points out, much of these kind of estimates are not really produced by economics

...most of the people I am talking about are not economists. They are really applied statisticians. Economics is primarily a way of organizing one’s thinking in considering incentives and costs and the interactions between individuals that we call a market but is really emergent behavior with feedback loops.
This is not an argument against quantification. What economists do know are basic facts, 
It is useful to know that 40% of the American work force was in agriculture in 1900 and now the number is 2%. It is useful to understand that that transition (which was most faster in the first half of the 20th century than the last half) did not lead to mass unemployment and starvation.
This is a fact, as distinct from a causal analysis. 
Economics leads you to great sensitivity to the fact that  correlation is not causation. That many workers lost manufacturing jobs while China was expanding does not prove that China's expansion caused those job losses, or that they would not have occurred in a world otherwise the same but with powerful trade barriers. Rich people drive BMWs. Driving a BMW will not make you rich.  This is the main reason why so many "studies" remain controversial, well covered by Russ. 
Still, we haven't answered well enough just what economics is good for. Russ: 
Economists generally believe that incentives are very powerful
I'd rather he had said "Economists generally understand.." as "believe" is not a good word for any scientific enterprise. Much of the world makes sense if you recognize the power of incentives.

Yes. In just about every policy question an economist sees an incentive. Where most of our political analysis sees an income transfer. Raise gas taxes? An economist sees an incentive to drive less, move closer to work, carpool, ride a bike, buy a more efficient car. Most of our political system sees only a transfer of income, with current habits unchanged.

But I want to go further. Budget constraints and accounting identities. I think good economists quickly follow the money one more step than most analysts. If you subsidize x, then you must take money away from y. If foreigners are not able to sell things to us, then they cannot get dollars to buy things from us, or to buy assets, or to invest in the US. There is no such thing as "real" vs. "paper" investment -- each person making a "paper" investment is buying someone else's liability, which funds a "real" investment. You can't make American's wages go up, say by banning nurses from the Philippines, and also health care costs go down. We can't all buy or sell stocks -- for every buyer there must be a seller.

Unintended consequences. Our field is, perhaps, best described as a collection of funny stories about unintended consequences. (I became an economist one day very young, reading a newspaper story about a program to get rid of poisonous snakes. The government had offered a bounty on each dead snake. Guess what happened. Hint: It's easy to raise snakes.)  Unintended consequences usually come from forgetting about incentives and budget constraints. My daughter, age about 8, looked up from reading the paper one day and asked, "Dad, if the government makes everyone buy fuel efficient cars, won't they just move further from work and use the same amount of gas as before?"

Supply response, (or demand), and competition. In thinking about banking regulation, a good economist focuses on incentives for new banks to come in, rather than just how to manage the existing ones. In thinking about health care, we are all talking about how to pay for it, not about how to get new competitors to come in and offer better services. In thinking about labor regulation, we forget that the worker's ability to quit and easily get a new job, from a new hungry business trying to unseat the old one, is his or her best defense against a shoddy employer. If a drug company grabs the only FDA approval for a generic and hikes the price up insanely, the answer is competition, let others sell the drug, not price controls.

As you see, I think we're pretty good at identifying causal channels that most analysts ignore, even if we are not always great at quantifying their relative significance. But "not zero" is usually an eye opener in public policy.

The fallacy of composition ought to be right up there with correlation is not causation. Roosevelt tried to raise inflation by raising prices. Alas, you can only raise relative prices that way.  Individually, it seems we can get ahead by getting a better bargain, but my gain must be your loss and the economy does not gain overall. What's good for a business, or a bank, is not necessarily good for an economy or a banking system. A local stimulus can work by transferring resources from somewhere else. That does not mean the overall economy benefits from stimulus. Negotiating better can help one, but only at the expense of another. We can't all negotiate better.

In sum, I think economics provides an excellent set of bullshit detectors. This is my stock answer about my own professional expertise. I may not know what makes the economy grow, or how monetary policy works. But I now with great detail exactly why the ten stories in front of us are all wrong, and typically logically incoherent. That is useful knowledge.

Russ has a lovely closing paragraph, which you might miss:
But an economist when considering a policy of banning autonomous vehicles can think of a lot of other impacts besides the jobs saved and the continuing deaths from human driven cars if such a ban is put in place. One of the things we would think about is how such a ban will effect the incentives to discover future innovation that might also people out of work. We would think about how putting more power in Washington would encourage lobbying for protection. We would think about the children and grandchildren of today’s workers and how restricting technology and changing incentives would affect things. These ideas are not rocket science. But they come easily to economists and not so easily to non-economists. Thinking like an economist is very useful.
So let's call it Hayekian humility. This is the hardest one for so many economists to admit, as we all like to play central planner.

Economics and economic history also teach us humility: No economist in 1900 could have figured out what farmers, horse-shoers, ice deliverers, street-sweepers, and so forth would do when those jobs disappeared. The people involved did. Knowledge of our own ignorance is useful. Contemplating the railroad in 1830, no economist could have anticipated the whole new industries and patterns of economic activity that it would bring -- that cows would be shipped from Kansas to Chicago, and give rise to its fabled meat-packing industry. So, in a dynamic economy, all the horse-drivers, stagecoach manufacturers, canal boat drivers, canal diggers, and so forth put out of work by the railroad, and their children, were not, in the end, immiserized.

So, economics should be much better at being the ark for simple lessons of economic history and experience. Alas our current professional training makes us pretty terrible at this.

PhD training in economics focuses on theory and statistical technique, and prepares you well to do academic research. There are occasionally requirements for economic history, but these are usually economic analyses of particular episodes, i.e. training to do research as an economic historian. The sort of simple facts that Russ mentions just aren't much covered.

This isn't necessarily such a terrible thing. Physics training also doesn't cover its intellectual history that much, except for the lovely practice of repeating classic experiments. But current physics theory encodes everything you need to know about the messy experience that distills that theory. So too, perhaps, one may feel that current economic theory encodes everything you need to know about the experiences that produce such theory.

Obviously, this is a doubtful proposition, but to some extent it's true. A supply-demand curve with a price control, showing how price controls, rent controls, and minimum wages produce shortages, really does encode centuries of hard-won experience. However, social science knowledge is obviously less durable than Physics, and we see how quickly economists, armed with the theory but not the experience, can come to doubt their own knowledge. Economic models are not literal descriptions of the truth, but rather quantiative parables.

Also, many of the "facts" aren't quite facts, and really are always up for review. If we start teaching lessons of history, for example, the old chestnut that stimulus is proved by the rise in output from WWII spending -- never mind the failure of output to collapse after WWII ended, the end of Roosevelt's war on capital, the failure of hundreds of other stimulus programs or the minor fact of a war -- or how the New Deal saved us in the Great Depression, will get passed on along with valuable nuggets such as dreary repetition of experience on the effects of rent controls. Many historical issues are no less settled than the current issues that Russ talks about!

Finally, PhD training really is vocational training to do research, not to advise public policy. The market test is pretty clear -- to do research, you don't need a broad based understanding of economic history. When a research project needs a particular history, it's easy enough to learn that.

So, don't sign me up quite yet as one of those ready-for-retirement economists who bemoan too much math and not enough experience in graduate school. Actually we need more math, as the kinds of stories people talk about especially in finance are well beyond our capacity to model.

But the lack of an ark of experience, especially on microeconomic issues where they are clearer, is noticeable.

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