Breakthroughs and brickbats

IT IS easy enough to criticise economists: too superior, too blinkered, too often wrong. Paul Samuelson, one of the discipline’s great figures, once lampooned stockmarkets for predicting nine out of the last five recessions. Economists, in contrast, barely ever see downturns coming. They failed to predict the 2007-08 financial crisis.

Yet this is not the best test of success. Much as doctors understand diseases but cannot predict when you will fall ill, economists’ fundamental mission is not to forecast recessions but to explain how the world works. Over the next six weeks we will be running a series of briefs on important economic theories that did just that—from the Nash equilibrium, a cornerstone of game theory, to the Mundell-Fleming trilemma, which lays bare the trade-offs countries face in their management of capital flows, exchange rates and monetary policy; from the financial-instability hypothesis of Hyman Minsky to the insights of Samuelson and Wolfgang Stolper on trade and wages; from John Maynard Keynes’s thinking on the fiscal multiplier to George Akerlof’s work on information asymmetry, the topic of this week’s article (see article). These breakthroughs are adverts not just for the value of economics, but also for three other things: theory, maths and outsiders.

More than ever, economics today is an empirical discipline. Thanks to the power of big data, economists can track consumer behaviour in real time or know almost precisely how much a good teacher is worth to the lifetime income of children. But theory remains vital. Many policy failures might have been avoided if theoretical insights had been properly applied. The trilemma was outlined in the 1960s, and the fiscal multiplier dates back to the 1930s; both illuminate the current struggles of the euro zone and the sometimes self-defeating pursuit of austerity. The Nash equilibrium describes an outcome in which everyone is doing as well as they can given the strategies of others; it explains how countries compete with each other to cut tax rates in order to lure global capital.

Nor is the body of economic theory complete. Big gaps remain in the understanding of financial markets, for example, and on how best to regulate tech platforms like Facebook. The shortfalls are particularly glaring when it comes to modern macroeconomics. From “secular stagnation” to climate change, the discipline needs big thinkers as well as big data.

It also needs mathematics. Paul Romer, who is heading to the World Bank as its chief economist, has railed against “mathiness”, the habit of using algebra to disguise ideological positions. Economic papers are far too formulaic; models should be a means, not an end. But the symbols do matter. The job of economists is to impose mathematical rigour on intuitions about markets, economies and people. Maths was needed to formalise most of the ideas in our briefs.

Thinking far and wide

In economics, as in other fields, a fresh eye can also make a big difference. John Nash was only 21 when he set out the concept that became known as the Nash equilibrium; Mr Akerlof had not long completed his PhD when he wrote “The Market for Lemons”, the paper that made his name. New ideas often meet resistance. Mr Akerlof’s paper was rejected by several journals, one on the ground that if it was correct, “economics would be different”. Recognition came slowly for many of our theories: Minsky stayed in relative obscurity until his death, gaining superstar status only once the financial crisis hit.

Economists still tend to look down on outsiders. Behavioural economics has broken down one silo by incorporating insights from psychology. More need to disappear: like anthropologists, economists should think more about how individuals’ decision-making relates to social mores; like physicists, they should study instability instead of assuming that economies naturally self-correct. This could make the maths trickier still. But not as hard as getting the profession to eschew its natural insularity.