September 15, 2009

Krugman on the state of economics

Posted in Miscellaneous at 3:06 pm by Eamon Aghdasi

I just got around to reading Paul Krugman’s New York Times Magazine article, “How Did Economists Get it Wrong?“. Brilliant breakdown of the shortcomings of economics as a social science as it stands today. If you haven’t read it already, I highly recommend it.

Here’s a bit that I think summarizes the article:

As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.

Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.

I’m definitely on board with this argument (let’s face it, it’s easy to recognize what Krugman’s talking about now that we’re on the heels of crisis, and much more difficult before the crisis’s onset). There is value in the “elegance” of an economic model, but I think too many economists have an obsession over elegance. I realize it allows for models that, had they not been oversimplified, would lose their usefulness. The stumbling block is not the simplicity of the models themselves, but the tendency to actually believe that the model is perfect in practice, that for instance, human beings are perfectly rational beings in real life.

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