As we get close to 2018, thinktanks and research institutions across the world are organizing events marking ten years since the beginning of the Great Recession, the 2008 crisis. Much of the discussion revolves around how the field has evolved and what economists have learnt in the past decade. They’ve been discussing various shortcomings in theories, their post-mortems of the crisis with varied insights and so on. But a major problem still remains. Why don’t economists get things right?
The ‘Unblemished’ track record
Economists have had a terrible track record of getting things right. There have been instances such as the Consensus Forecasts in 2008 where they had a positive outlook on 77 economies they were tracking and by 2009, 49 of them were in recession! If someone were to make a meme on this, I’m pretty sure it would read “You had one job!”. Some might say “no one saw that coming, let’s be fair and cut them some slack”. Fair enough. Let’s entertain this argument for a bit.
If we were to expand the time horizon of the analysis, nothing much changes. Prakash Loungani, an economist at the IMF, studied to predictive accuracy of forecasts from 1989 to 1998. In his conclusion while answering the question of how accurate these forecasts are, he remarks “The simple answer is “not very well”. Only two of the 60 recessions that occurred over the sample period were predict a year in advance, two-thirds remained undetected by the April of the year in which the recession occurred, and in about a quarter of the cases the forecast in October was still for positive growth (albeit small)”. One of the famous quotes from his paper is “The record of failure to predict recessions is virtually unblemished.”. Some have even likened this track record to those of fortune tellers and tarot card readers!
There are thousands of economists all over the world working on economic issues and getting paid pretty well. There is even a Nobel Prize for this “science”. Then why do they still get it wrong so often?
There are many factors which contribute to the inaccuracy. The primary reason is that the world is simply too complicated to be understood leave alone being captured in a model. This is something which all economists accept. Then there are issues relating to the operational aspect of the science such as its assumptions and tools. Many have criticized the flawed and unrealistic assumptions that economic theories and models have such as ‘rationality’ – that humans are rational and seek to maximize their utility. Humans are anything but! Political economists have been trying to liberate economics from these rigid and unrealistic assumptions for decades. The complicated mathematical and statistical tools that are used have also been criticized for their accuracy. But there is a far more deep-rooted problem.
Economics fails to recognize the nature of reality in which it operates.
The nature of reality
George Soros’ Theory of Fallibility, Reflexivity and Human Uncertainty Principle. In 2014, the Journal of Economic Methodology had an entire issue based on his theory. His theory is very simple and elegant. In his theory he mentions something that is of importance.
Soros distinguishes between Natural phenomena and Social phenomena. In the case of natural phenomena, thinking plays no causal role. There is cause effect taking place without the subjective aspect of reality. Based on the knowledge obtained, one can manipulate the natural world to attain objectives. One could plant a seed and keep watering it and in a few weeks or months, you can harvest it. One’s thoughts don’t affect the laws that govern the plant’s growth. However, social phenomena are much more complicated. Here, subjective reality can affect the objective reality. Take for example the price of a stock. While the information one has is affecting the price of the stock, the price of the stock is also affecting the information one has (this goes against the dominant economic theory that markets are efficient).
Yuval Noah Harari in his book Sapiens, talks about factors that led to the rise of Humans as the dominant species. One of the factors he mentions is our ability to imagine. Imagination and shared beliefs enable us to overcome the natural limits of coordination and cooperation. It enables us to cooperate with millions of people around the world. Religion, companies, nations are all such examples.
Economists miss this fundamental point. The reality which they are dealing with (the world) is a manifestation of our imaginations and beliefs. It is because Jeff Bezos imagined doing business over the internet that it manifested itself in the form of Amazon. One could even link this to the evolution a large and thriving ecommerce sector. Steve Jobs imagined a smartphone and manifested it in the form of an iphone.
This has serious implications for economics. During the early periods of the field’s growth, in their pursuit to impress their fellow colleagues, economists declared economics a science like physics. They believed the world ran on certain basic universal laws and it their job to discover them. They believed in an objective reality that has always been there. This can be seen in the language they use to describe the world.
But this isn’t the case. Imagine having a conversation with our hunter-gather ancestors on companies and the stock market and nations. They would find it difficult to understand what we are saying and probably laugh at us! We have evolved and come a long way. Our imagination and ability to manifest it has affected our lives and so have our lives affected our imagination. The reality which we live in is our creation and not something which has always existed. As our beliefs and imagination shift, so does our reality.
Sociologists have been able to recognize this flow. They call it ‘performativity of economics’. The argument put forth is that economics ‘does things’ rather than simply describing the world we live in. It creates things and shapes reality in the process. The most often cited example is that of the financial markets (which again is a creation of our own). Economists must recognize that the social reality they are trying to study is a manifestation of our imagination and beliefs. It is a human creation which is fluid and dynamic. Recognizing this itself is a very big step and will open doors to new possibilities which are being kept out now.
-Contributed by Bhargav Dhakappa
Picture Credits: pinterest.com